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• TAO of Flipping and Investing in Real Estate - Part 5 - Calculated Risk

  Ask anyone that is an investor of real estate and they will tell you about how they were burned on a deal, missed a opportunity, or lost a lot of money due to ignorance of not understanding what they were doing.  As I once heard the world renowned speaker Zig Ziglar say, “If you haven’t failed at what you do, you will never succeed” - simply put, failure teaches us how to learn from our mistakes and correct our errors.

  Being able to calculate risk takes many years to fully understand and apply, but I would like to take this opportunity to give a bit of insight on how you can start to think critically and apply risk management techniques to your real estate purchase.  Properly evaluating your risk will give you the pretense for prevention and ultimately lower your risk of failure.

  In real estate investment, the ultimate goal should be to profit on purchased and controlled assets.  To do this, you need to be able to both successfully and consistently acquire and sell your investment for profit.  The only way to do that is to be able to recognize value, acquire it at a substantial discount, and sell it under desirable conditions.

  Recognizing value is an essential factor in being able to profit on investment.  To evaluate value, you must know the market area of the property in question so you can provide a comparable market analysis of the property based on location and recent home sales, be able to inspect the property with reasonable knowledge of most aspects of basic home repair and be able to appraise the value of the home and its amenities.

  Once you have developed the ability to determine what the value of a investment is to you, your finally ready to manage your risk.  In managing your risk, you are essentially accounting for all scenarios that will affect your purchase price, cash flow during asset holding and the pre-determined exit strategy.

  The purchase price should be determined by using the following:

  • Current Home Value
  • Closing Costs
  • Determination of Rents Based on Debt Service and Expenses
  • HOA and Utility Fees
  • CMA of Current and Repaired Market Value
  • Title and Encumbrance Search
  • Repair Costs
  • Analyze List Price /Sales Price Ratios
  • Obtain Property History Report
  • Determine what your Profit Must Be
  • Pre-determined Cash Flow analysis

  The cash flow analysis of your investment should have accounted for the following:

  • Home Owners Association Fees
  • Interest Rate
  • 10% Property Management Fee
  • 10% Rent Loss
  • 5% Maintenance Fee
  • 5% Marketing Fee
  • Principle, Interest, Taxes and Insurance
  • Down Payment
  • CMA on What the House Will Rent For

  The exit strategy should be determined before you even buy the house and depending on whether it is long or short term holding, the following should be evaluated in your selling price:

  • CMA on Retail Market Value
  • Holding Costs for 3 Months (PITI x 3 Mos)
  • Realtor Fees (6% of Sale Price)
  • Marketing
  • Closing Costs (3-5% of Sale Price)
  • 1031 Exchange

   ——

  Calculated Risk is an asset to any investor and is used by most all good investors alike.  Being able to calculate your risk into your purchase price, holding costs and sale will allow you to maximize your profit potential and ultimately help you to be successful as a investor.

  
  

• TAO of Flipping and Investing in Real Estate - Part 4.6 - Making the Offer

  Making an offer on a investment property is much like pulling the trigger on all the work you’ve done.  After researching the actual value of your prospectus and doing the due-diligence on the liens and encumbrances it will be easier to make a offer that will be acceptable to both the buyer and seller.  Hopefully the offer includes the calculated risk of the purchase and the offer is adjusted accordingly.  Additionally, whether it be holding for long term or flipping for quick profit, knowing the exit strategy of the purchase should already be identified and planned before the offer is submitted. 

  Two elements of investing that should be addressed when making a offer is whether the property will appreciate quickly or if it would be a good cash flow property.  Most investment properties will be one or the other.  A property that might be in a good area with fast appreciating values is not always a good rental property that will cash flow.  Most homes that have quick appreciating sell for far more than the mortgage to rent ratio would allow, but a good cash flow house will usually be bought for less than the mortgage to rent ratio allots and will increase in value at a slower rate.

  Example 1

  • You bought a home for $100,000 that you determined the rents are $1200.00 a month and the mortgage payment with a PITI (principal, interest, taxes, and insurance) is $900.00.  After calculating in your management fees, maintenance, rent loss, marketing etc.. you determine that your monthly cash flow is $25.00.  This property will continue to show minimal profit and increase over time, but the value of the home itself will not go up very fast.

  Example 2

  • You bought a home for $200,000 and the rents for this home were determined to be $1500.00 and the PITI is about $1800.00 a month - as you can see, your already paying more for the mortgage than the rents will bring in.  In this case, the property needs to appreciate at a fast rate, otherwise you will own a alligator that will eat you alive in debt.  We didn’t even calculate in your management, maintenance, rent loss, marketing etc.. so realistic expectation should be a negative cash flow of possibly more than $500.00 a month.  

  From these examples, both can make an investor money, but understanding whether the investment will appreciate or cash flow is very important.  For this reason alone, investing is not something for the faint of heart to try to do.  There are things that can and will go wrong on every purchase - being prepared and calculate your risk ahead of time to help prepare you for these potential problems.

  
  

• TAO of Flipping and Investing in Real Estate - Part 4.5 - Determining a Rent Price

  Determining what you will charge in rent for your investments may sound very cut and dry but it is not.  The rent price will determine how fast you will get the home rented, whether your going to be making mortgage payments while it sits, and the type of renters that will be calling.  Being able to adjust your rent to coincide with your needs is not only important, but crucial to investing and overall cash flow.

  Although renting a home is primarily for long term investors, it pertains to flippers and short-term holding as well.  Knowing what your house will rent for will determine what people you can market  and sell it to.  If it is an expensive home and the rents cannot warrant the mortgage a buyer will make, you will be stuck with marketing it to homeowners and long-term investors.  If the homes rent is equal to or close to what the mortgage will most likely be (this includes taxes and insurance), the market is much wider - to include investors and potential home buyers.

  If you own a house in a sub-division where all the houses look alike, how will you stand out?  As much as renters like pretty flowers and a big back yard, that is not what will bring them to renting your homes.  You may have learned in economics that supply and demand drive prices, this is true in stocks and its true in real estate.  Having the ability to determine where to price your rental is crucial for this reason - if there is too much supply (too many rentals in the area) then there will be less demand and you will have trouble renting out your home.

  I have a bit of a different take on this theory, but it essentially still follows the same rule.  If you can buy for the right price, you should be able to rent for the lowest price thus beating the market.  What this means is that you not only need to buy your investments for a better price than most, but you need to be able to rent them for lower than everyone else!  By doing this you are essentially doing two things: assuring yourself of a more viable rental because you have a more enticing rent price than the other homes in the area and you have lowered your calculated risk because you have increased you chances of renting your units quicker.

  If there are 10 homes on the same block that you just bought in, all were about the same look and size, and everyone had their house listed for rent at 1000 dollars, which house would rent first?  The answer is not really known because they all are equally marketable due to price.  Having a hut tub in the back yard, or a larger game room is fine, but renters care more about price than those things.  Now, if you had bought a house on this same street but you had added in all your expenses and could rent your house for 900.00, you would be more likely to rent your house than the other 9 on the block.

  The importance of pricing is not to determine just how much cash flow you will make, although this is important - it’s to determine your ability to get renters to sign a lease!  If you can buy a house for the right price and have used the rents of other houses in that area to determine your purchase price, you were able to determine what you would be able to rent your house for.  You should be able to discount your rents by at least 15% of the retail market and still come out even.  If you cannot do this, you are not able to account for the risk involved in buying real estate and being successful.

  Lets say we came into a recession and those 10 houses were all vacant, they all have not been able to get a renter because the apartments nearby are slashing prices to take the renters away from your market - what do you do?  Well, if you did like I told you, you will be able to discount your house more than the others on your block because you have calculated your risk and were able to lower your rents to equal or lezs than your competitors at the apartments.  This is how you will be and stay successful in keeping your houses rented.

  Now that you understand why you need to be able to compete against others in your local area, lets move on to how to determine what to rent your investment for.  This is not as hard as it seems, although it does require some practice to be good at being able to set your rents right the first time. 

  The first thing you can do is drive the neighborhood and call the people that have signs in their yard.  You will be surprised at how much information you can attain by calling the owners.  Next you can look in your local papers and online for the houses that are in your neighborhood and call them as well.  Lastly, find a local realtor that know the area well and have them pull a list of all the houses in your area that are listed or have rented in the last 6 months, this is the best way to determine your starting rents, but is also tough as times because the realtor might be a bit apprehensive if you are only using them and may not work with you in the future.

  Once you have set your rent price, you will test the market.  First try setting it 3-5% above the market price and see if you get any callers, if not, you will start to lower it 3-5% at a time until you have people calling regularly about your rental.  Eventually, you will have a good grasp on the market area and will be able to immediately determine your rents and will take less time researching.  Always remember that whatever your rent will be, you need to be able to discount that by at least 15% in case there is a turn in the market and you need to start slashing prices to beat the competition. 

  
  

• TAO of Flipping and Investing in Real Estate - Part 4.4 - Repairs

  I always have fun talking about this subject because it can be very subjective for the most part and takes years of experience to master.  Being able to assess the costs of repairing a residential property, office building, or really any permanent structure can be a daunting task.  Not only is it important to be as knowledgeable about the costs of the different repairs that may have to be made, it is essential in determining your purchase price.

  There are many ways to get accustomed to working with contractors and handymen, but the method I prefer to use is referrals.  If you have a close relationship with some handymen or contractors in your area, you may approach them for referring you to a plumber, painter, carpenter, electrician, and even other handymen, although they may be a bit reluctant for the handyman referral.  I have had great experience in the past by doing this, and you will too.

  You can also coordinate with your realtor to have 3 or 4 contractors look at a specific project and give you bids on them.  For example, if you have a nice little fixer that your looking to purchase and it has some foundation problems, you may work with your realtor to make the house available so you can have multiple foundation repairmen to come in and give you a bid.  You will not only learn about what the prices are for a certain repair, but you can deduct what your costs could be for other similar repairs on other houses you might be looking at.  This method can be applied for other types of repairs as well.

  Not all Realtors will be willing to work with you, I know — you may have to build a working relationship with a broker or realtor that is willing to take a chance on you.  Show them the money and they will show you the love seems to be the way it is.  If the house is not one that is listed with a realtor, you may be able to have the owner let you in the house to evaluate it for purchase and even if someone has a realtor for their house, you can still talk to the owner if you can find their contact information.  Most owners that are using a realtor are typically going to ask you to call the realtor, hate to say.

  If you have trouble being able to evaluate properties for repairs it is also common to hire a general contractor to oversee and handle all contracting on your repairs.  There are many ways to locate general contractors and foremen such as your local paper, hardware store classified ads and even through sites such as www.craigslist.com.   They are usually not used for small jobs, but if you have a significant repair with a lot of different contractors needed, this may be the way to go.

  Flip This House - Ok, some of you have seen this show and most that have think that by watching it you have been able to hone the skills needed to do a flip or learn the tools you need to buy investment property.  Watch Out!  These shows do not show you the real costs involved, nor do they divulge all the repairs that a house may be needing.  Being able to smooth-talk and handyman into a low bid does not make you a quality or successful flipper.  If you cannot evaluate a property yourself and figure a close value of the repairs and cost, you will most likely get screwed by any handyman or contractor no matter how honest you think they are.  Its the way it is, learn to negotiate like a champ, or learn how to evaluate repairs!

  Don’t rush to find a handyman, make sure you get multiple bids on a project and always pay close attention to what they say while looking through the house.  You may hear one handyman say there is a leak in the roof and another totally misses it, this is another reason its good to have a handyman or contractor walk through the house before you start tallying repair costs.  If all else fails and you cannot get someone in to look at the house, move on to the next deal and start keeping a log of the contractors you have called so you can build a team of people to help you get started.

  
  

• TAO of Flipping and Investing in Real Estate - Part 4.3 - Monthly Expenses

  In the art of flipping and investing in real estate there is always a part of the puzzle that some will almost unanimously agree on — the expenses that you will account for over the course of each mortgage payment you make on your investment is this important puzzle piece.  Understanding what deductions you will account for and properly applying this to your monthly mortgage will ultimately tell you how much cash flow you will have each month, what your offer price will most likely need to center around, and give you a over-all understanding of how much cash will be going torward the payments and maintenance of your new investment.

  There are 7 things you will need to account for when you are purchasing a house for investment or even to flip; understanding what they are and how to properly apply them to your monthly mortgage and cash flow will help make you be successful in investing.  Pay close attention to this section, because it is one of the most important areas of investing that many people either don’t grasp, or overlook.   The 7 things you need to account for in your deductions are:  mortgage, taxes and insurance, rent loss, maintenance, HOA, management fee, and holding and closing costs.  I will share information about how much you should alot to each area and explain why each is important in figuring out your montly house payment and cash flow.

  As a precursor, it is important to remember that these 7 expenses we will cover both make up the over-all monthly payment and your allotments for necessities to assure you are minimizing your calculated risk of your investment.  By accurately and carefully applying these expenses, you will essentially lower your risk to an amount that is easily acceptable by investor standards and will make your liability low enough to warrant any purchase that meets this criteria.

  #7.  Mortgage - Whether you have an A.R.M. loan, seller carried loan, or one from the government or bank — you will be responsible for making a monthly payment to a loan company that will require you to pay somewhere between 80-95% of your loan payment as interest and as little as 5-15% as principal in your first 3 to 5 years fo your loan.  In a 30 year fixed loan, you can expect to be paying more toward your interest than your principal until near the 10th year of the loan.  As you can see, most of your mortgage payment will go toward your loan holders interest for at least a few years.

  The mortgage payment will make up the bulk of your payment on your investment, so be sure to pay careful attention to what your interest rate is and how long your loan is for.  Most lenders will charge a premium interest rate for loans that are considered for investment, so keep this in mind when attempting to purchase a property with the some purpose of investing or flipping it.  Secondly, some loan holders will require you to pay your taxes and insurance along with your mortgage, this is often considered an escrow holding — the lean holder will essentially have you pay your taxes and insurance along with the mortgage to then and they will in turn make the payments on your behalf for your taxes and property insurance.

  #6.  Taxes and Insurance - Your taxes and insurance are most likely paid by mortgage company unless you are able to manage your own escrow in which case you are responsible for paying your property taxes and insurance yourself.  This usually will make up about 15-30% of your mortgage payment depending on what state and city you live in. 

  Be sure to shop around for a good insurance company; much like your car insurance, there are many different companies you can choose to go with for home insurance, and some offer great deals for having multiple houses and your car attached to the same owner.  As with shopping for insurance,  be sure to try and address the property tax cost for your investment as well.  Most counties will allow you to lobby to have your taxes lowered for your property if you can justify why you may be paying too much.  If you can get comparables for other houses and find what they are paying for taxes, see if you can get yours lowered to be more comparable  to theirs.  Believe it or not, this is a very good strategy that often works and more importantly will lower your over-all taxes if successful.

  #5.  Rent Loss - Anytime you own a investment property or a flip, there will be some downtime on the unit.  This needs to be compensated for and the best way to address this is by adding approximately 10-15% of the total monthly mortgage as a expense.  If your mortgage payment is $1000.00 dollars a month, you could add $100.00 to that and virtually say that you need to rent the house for 1100.00 a month to cover not only your mortgage every month, but also to account for 1 to 3 months of rent loss or downtime for repairsand finding a renter.  By doing this, you are putting a fail-safe buffer into your expenses that will allow you 1 month of no tenant and still be able to make your mortgage payment without out of pocket expenses.  It is important to always add this into your expenses and if you can succesfully account for more than 1 month of rent loss added in, the more buffer and time you have for getting that house rented out!

  #4.  Maintenance - No matter how old or new a house, there will be problems and you will be responsible for fixing them.  To help alleviate this worry, you should always try adding about 5-10% in expense to the mortgage fee for repairs and upkeep.  By doing this, you can have money set aside to make any last minute or annual repairs that are needed on the property.  Some of the most common repairs are water heaters, HVAC, plumbing, and sometimes roof repairs.  The average cost for a major repair is $1200.00 dollars annually; so having this buffer will not only help to cussion your costs for any repairs, but will lower your over-all risk because you have alloted for repairs in your monthly payments.

  #3. HOA - Most sub-divisions have what is known as a Home Owners Association (HOA), these HOA’s will provide services such as monitoring neighborhood restrictions, maintenancing community ammenities, and maintaining the over-all upkeep of the sub-division grounds.  Associated with this service is usually a fee that is paid monthly to the association for the services.  This is a expence you will be responsible for whether your renting the home out, or preparing it for a flip.  Typical costs can range anywhere between $50-100.00 quartely and are usually paid at the beginning of the calendar year.  Failure to pay your HOA fees can result in law suit and ultimately foreclosure of your investment, so keep on this cost, it is important–if your in a sub-division that has a HOA.

  #2.  Management Fee - Do you do all the rent collection, repairs, late night phone calls, coordinating showings and even managing the bank accounts all yourself?  Whether you said yes or no, you still need to add a management fee into your monthly expenses.  If you are paying someone to manage your investment or flip you are most likely paying the typical 10% of the monthly rents toward this fee.  Again, this will need to be added into the monthly expences that you will add to your monthly mortgage costs.  So be sure the calculate this into what the house rents for, so it is covered.  If your managing the house yourself, do you work for free?  Of course not!  You need to be paying yourself, so still be sure to add this into your expenses.

  #1.  Holding and Closing Costs - These fees are typically associated with flipping or selling a home, so if your only investing and plan on renting out your property, you may use this in your analysis of your monthly house payment cost, but it is not necessary.  The holding and closing costs are the fees associated with the mortgage payments you will make while the house sits waiting to sell and the ultimate closing costs you will pay to close the escrow on the property. 

  The holding costs can add up quickly if your property takes 2, 3 or even 4 months before it is ready to sale, so be sure to account for this in your purchase price, so that when it comes time to sell, you arent going negative!  Additionally, when you sale the home, you will be responsible for paying for some closing costs — usually .5 to 1% fo the total sale price of the property.  If you are selling a $100.000 home, you can be sure you will be paying about 5-7K in holding and closing costs.

  If you put all 7 expenses together, this is what it may look like in your spreadsheet: 

  $ 50,000               Purchase price of home worth about $100,000 that will rent for $1000.00 a month

  ————————————————————————-              

  $ 375.00               Monthly Mortgage (principal/interest)

  $ 200.00              Monthly Taxes and Insurance Fee

  $ 100.00              10% of Monthly Rent for Rent Loss

  $   50.00              5% of Monthly Rent for Maintenance

  $   15.00              HOA Fee ($15.00 x 12)

  $  100.00             10% of Monthly Rent for Managenet Fee

  ——————

  $  890.00             Total Monthly Expenses

  As you can see, on a home that was purchased for $50,000 dollars and is worth about $100,000, you may come up with a total monthly expense of $890.00.  This left us with a cash flow of about $110.00 a month and will give us peace of mind because we have made every effort to account for any expence that can be thrown at us.  Of course, with any formula, we cannot account for EVERYthing that can happen, but for the most part, we will be able to sit back and let this property develop and become a true investment.

  In the case of buying and selling  a property to flip, we need to apply everything to our purchase and sale  price that was listed above accept we also need to calculate in the holding/closing costs to determine whether the house is a good deal or not.  I will next show you how this is done in the next spreadsheet:

  $  50,000.00         Purchase price of home worth about $100,000          

  $  2,700.00            Monthly Holding Cost ($890.00 x 3) (same as monthly expenses)

  $  2,000.00           Closing Costs for SALE of $100,000 flip

  $  3,000.00           Closing Costs for PURCHASE of investment flip

  $  6,000.00           6% realtor fee for Sale of Flip

  $ 15,000.00          Repairs (this is variable, could be less/more)

  ——————

  $  78,700.00         Total Expenses for Purchase/Sale over 3 Month Period

  This could potentially give us a 21,300 profit for the sale of our Flip!  We purchased a property that is worth $100,000 in great shape for only $50,000 and after all oyr expenses and selling the property, we realized a profit of $21,300.  This is only an example of how a typical flip may look, but I hope you get the idea.

  The whole purpose of taking the time to do the calculations for our expenses is to lower our calculated risk.  As long as the risk is low and we can purchase the property for a price that can warrant, based on our formula, it will not only be a sound investment, but a profitable one.

  Class Dismissed!