Creative Approach to FREE Property Management

I met an investor that has a unique approach to RE investing. He has very little headache with renters because of this win-win philosophy. He looks for people in his community that have a down payment and want to buy a home but cannot qualify for a loan . He offers them a 25% stake in a multi-family that he buys. He puts in his own money for the rest and moves them into one unit in the building. They pay whatever rent is the standard for that unit. They get their share (25%) of revenue from the building later. This way, the building gets taken care of automatically. Since they live in a building they own, they keep an eye on the other renters, no surprises, no trashing. One unit (that they occupy) is permanently rented, no need to pay a property manager. Everyone is happy. This person has several such units he co-owns. Never paid a penny for property management.

I see a few flaws in this concept. But overall, I think it's brilliant. This is why I love real estate investing. There's so much room for creativity!

HUD List Price to Sales Ratio (Hartford County)

Have you thought about buying a HUD Foreclosure? The chart below will be pretty helpful for you. I looked at 90 HUD single family properties that sold in Hartford County between 1/1/14 - 5/31/14. I wanted to know if there was a magic number that they would accept when considering offers on properties.

 

 

As you can see in this chart, HUD gave the greatest discount off of the list price between 61-90 days on the market. This should make it a little easier for you when considering making offers on HUD properties. Just make your offer at about 88.79% of the list price and it should get accepted. Of course if you're making this purchase as an investment, make sure that these numbers line up with your acquisition strategy.

 

If you'd like a detailed analysis on your local market, email me here.

What is Gross Rent Multiplier

Gross Rent Multiplier is a simple calculation but because income plays no role in the formula, it provides limited insight into the apartment’s investment viability. Gross Rent Multiplier (GRM) is also easy to calculate but unlike Price Per Unit, GRM does incorporate the property’s income.

Gross Rent Multiplier = Price / Gross Scheduled Income (annual)

Gross Scheduled Income is the potential income a property would generate if it was 100% occupied. You can think of GRM as the number of years it would eventually take for the property’s gross income to total the price.

Example: A 10-unit apartment building is offered for sale at $1 million. Each unit is 2Bd/2Ba and is renting for $1,000. What is the Gross Rent Multiplier?

Gross Rent Multiplier = $1,000,000 / (10 x 1,000 x 12) = 8.33 GRM

As long as you can get your hands on the rent roll, then the Gross Rent Multiplier measurement is preferred over Price Per Unit. Generally speaking, properties in prime locations have higher GRMs versus properties in less desirable locations.

Advantage – It’s More Useful and Reliable than Price Per Unit
Pop quiz, what are you buying when acquiring an apartment? You’re buying income stream. Given the fact that GRM accounts for income into its formula automatically makes it a more reliable method for evaluating investment properties compared to Price Per Unit. Additionally, by taking into account income, property features are automatically factored into your evaluation. It’s reasonable to assume that rents reflect unit size, amenities, location, and even external factors such as general market conditions that may add to or deduct from its price level. Rents are market driven – you can only charge as much as a tenant is willing and able to pay. By factoring in a market-driven data point (income), GRM is more reliable as a measurement for comparing properties. In areas where operating costs can be expected to be uniform across properties, GRM is especially useful for comparing and selecting investment properties for further analysis.

Limitation – Ignores Vacancy & Operating Expenses
Gross Rent Multiplier serves to indicate what the market is paying as a multiplier of the gross income. As explained above, gross income is generally a good data point because its market driven and accounts for enhancements and deficiencies of the property as well as general rental demand. But because it is gross instead of net income, GRM fails to differentiate properties with lower or higher operating expenses and vacancies. Tenants may pay for some, all, or none of the operating expense. For example, a landlord may pay for all utilities because the building is master metered. This will result in higher rents compared to an identical property where those costs are directly passed to tenants. If you were estimating the price between the master-metered versus the individual-metered property using the same GRM number, then this would result in a very questionable value.
As with Price Per Unit, it’s important to understand the reason to use Gross Rent Multiplier. Always keep in mind the above limitations and remember that its purpose is to get a quick feel for the potential market value of the apartment.

Is "Price Per Unit" really important?

If you’re evaluating many apartment investment deals, oftentimes you need a quick way to determine ones that warrant more detailed analysis. After all, your time is valuable and any time spent analyzing deals that don’t make sense from the very beginning may result in other lost opportunities. What you need are techniques to act as filter mechanisms and help you quickly decide if the investment deal will really work.

Price per Unit is often used because it’s simple and quick to calculate.

Price per Unit = Price ÷ Number of Rental Units.

 

What makes it popular is that it’s easy to gather the necessary information to run the calculation. All that’s needed is the asking price and the total number of units.
Example: A 10-unit apartment building is offered for sale at $1 million. The property has a total of 20 bedrooms and 20 baths. What is the Price per Unit?

$1,000,000 ÷ 10 units = $100,000 per Unit.

If the general price per unit rate is $50k per unit, and the property is offered at $100k per unit, then red flags should be raised immediately. If evaluating multiple deals, this might be one you choose to set aside.

Precaution #1 – Neglecting to Factor in Property Features
What if the general rate in the area was $75,000 per unit? Will you still be quick to discount the property? One precaution to take with Price per Unit is that it doesn’t take into account property features such as amenities, location, or floor plans. Each of these can add or subtract to the Price per Unit value. Let’s say the 10-unit subject property’s 2bd/2ba units are generous in size at 1400 sq ft each. Other surrounding properties have outdated floor plans with only 2bd/1ba models and average 800sq ft each going at the general rate of $75k per unit. The higher price per unit of the 10-unit apartment would then be warranted because of its more modern features and larger floor plans. If you were strictly comparing price per unit rates, then you may have dismissed this opportunity by thinking the property was overpriced.

Precaution #2 – Ignoring the Investment Feasibility
Since Price per Unit is based on the physical feature of the property, it’s really a physical measure, not a true financial measure. Because the income is never reflected in the formula, price per unit provides little insight towards financial feasibility of the investment property. You can’t derive from it whether the investment property will provide a suitable return or not. A property could be offered at a low price per unit but still turn out to be a horrible investment because of negative factors such as bad location or problems due to deferred maintenance. Alternatively, a high price per unit doesn’t necessarily mean it’s a bad deal as illustrated in the section above.
Price per Unit is easy to calculate so it’s often a good initial measure to use. However, keep in mind that Price per Unit only looks at the number of units; it completely ignores everything else about the property including its features, location, and income and is limited in its usefulness. Therefore, if the deal passes the Price per Unit test, then move on to the GRM test or the Cap Rate test.

What is a Cap Rate? (Capitalization Rate)

What is Capitalization Rate?

I'll give you the short answer and the more descriptive answer... The short answer is that the Capitalization Rate is the rate of return that you would expect if you were to purchase a property using all cash (no financing). It's just that simple. But I'll dig a little deeper so you fully understand what it is and why it's so important.

The Capitalization Rate, often referred as Cap Rate or just Cap. It is similar to GRM but can be more precise because it considers vacancy loss and operating expenses.

 

Cap Rate = Net Operating Income / Price

Net Operating Income (NOI) is the sum of all potential income less vacancy and operating expenses. NOI does not consider debt payments, depreciation, or capital improvements.

Calculating Cap Rate: An Example

A 10-unit apartment building is offered for sale at $1 million. Its annualized rent roll is $100,000 with operating expenses totaling $40,000. What’s the Cap Rate if average vacancy rate in the area is 5%?
Capitalization Rate = ($100,000 – ($100,000 x 5%) – $40,000) / $1,000,000 = 5.5% Cap
If you know the going Cap Rate for the area, then you can also derive the property value from the NOI.
Cap Rate addresses the limitations of Price Per Unit and Gross Rent Multiplier by including income, vacancy loss, and expenses in its calculation. However by doing so, other problems are introduced.

Precaution #1: Is the Cap Rate Distorted?

Capitalization Rate isn’t flawed, per se. The problem is with Net Operating Income. More often than not, NOI may be inaccurate, which distorts Cap Rate and consequently, misrepresents the estimate of value.
The inaccuracies stem from three primary reasons:

1. Misrepresented expenses
2. Excluded expenses
3. Improper expenses factored into the calculation

Common expenses include insurance, property management, real estate taxes, business fees, maintenance, trash removal, electricity, gas, and water. While reviewing each expense item, confirm the validity of each number. Try and obtain the actual amounts rather than estimates. Are items inappropriately labeled as operating expenses? Remember that depreciation, capital improvements, and mortgage payments are excluded.
Ensuring that expenses are complete and valid will enable you to estimate a more credible value.

Precaution #2 – Is the cap rate calculation based on current or pro forma numbers?

Sometimes sellers or brokers will base their asking price against the future income of the property. This future income is almost always higher resulting in a higher Cap Rate. This tactic is used to lure the unaware investor.
While it’s important to understand the potential upside in rents, projected numbers shouldn’t act as your baseline for estimating value. When estimating value, use current income and expenses. Then evaluate how much premium you’re willing to pay based on projected increases.

Precaution #3 – Financing is not considered.

Investors often use Cap Rate to gauge the potential return of a given investment property during the first year of ownership. Generally, a 10% Cap would indicate a 10% return on investment. Based on expected return, the investor then determines how much they are willing to pay. For investors who pay all cash, Cap Rate enables them to quickly do this.
Since NOI does not consider debt payments, Cap Rate ignores the impact of financing. Cap Rate stays the same whether a property is leveraged or all paid off. If financing is planned, then Cap Rate cannot be used as an estimate of value. Additional methods (ie. cash-on-cash or IRR) are required to assist in that task. However, Cap Rate is still useful as a comparison tool even with financing involved.

3 Commonly Overlooked Property Expenses

I’ve seen many different spreadsheets and pro-formas over the years, calculating potential return on investment for a given rental real estate investment. It’s not uncommon to find wholesalers inflating returns by eliminating all sorts of typical expenses (ie. vacancy, property management, insurance, etc). While this may trip up a newbie investor, most folks know to build in the usual expense categories when developing a pro-forma. Even so, I find it interesting how infrequently I’ll see the following three categories in a typical ROI calculation:

Turnover

What is turn-over expense? It’s money spent on a property when a tenant moves out to get the property ready for the next tenant. Inevitably, when a tenant moves out of a property there is some level of work needed to get the property in marketable condition. Most investors will touch up walls and paint (if not completely re-paint), clean and replace flooring as needed, take care of minor handyman items, etc. All of this can easily add up to over $1,000 (and sometimes much more) depending on the size of the property and the condition that it was left in.

While most investors have a line item for maintenance in the pro-forma, I find that it’s rarely enough to include turn-over expenses as well. Maintenance is really an ongoing budget item as repairs will inevitably be needed over the life of the property. Turn-over expense is really associated with the moving in and moving out of tenants.

Bookkeeping/Tax Prep

Another budget item that may or may not belong on a specific property proforma, but should be calculated nonetheless is bookkeeping and tax preparation. For the small investor who doesn’t mind tracking expenses and doing his own taxes, this may not be an issue. However, for the investor with multiple properties and an operation more like a business with properties in multiple LLC’s, it’s likely that there are costs associated with bookkeeping and tax prep. It’s important to include these figures when evaluating new properties for acquisition.

CAPEX

CAPEX stands for Capital Expenditures and pertains to big ticket expenditures that increase the useful life of the property. I think the most obvious CAPEX type expenditures on residential properties are items like the roof, HVAC, water heater, etc. I consider this slightly different than maintenance because they are higher cost items.

It’s very common for investors to buy a property with an old roof or an old HVAC and not budget for future replacement. For example, if you determine that you only have 5 years left on an old roof and you determine that a new roof will cost around $5,000 to replace … don’t you think you should budget $1,000 per year for the next 5 years to cover this expense? It seems obvious, but I almost never see investors doing this.

Understanding the true cost of an investment is one of the most critical elements to successful investing. It’s important that investors use accurate numbers and budget for all appropriate expenses associated with a potential acquisition.

Creative Strategies on Selling Properties in a Down Market (Q&A)

 

Click Here to email me your real estate investing question

Question: Cameron thank you so much for this (Q&A) segment of your blog. You have some really good advice in which is why I'm coming to you with this question... I live in West Hartford now but I have two houses in Puerto Rico that I can't think of no exit for the next 5 to 10 years. One I own free and clear but it is located in a non desired area. On top of this, the way it is constructed makes it hard to get conventional financing so it can only be sold to a cash buyer. I have rented it in the past but it has been vacant for the last 5 months.
The other is a condo that it is located near a medical and law school. It's currently rented and I don't owe much more on it. I would love to find a creative way to get rid of both of this properties. What makes the exit hard, is the current economic situation of Puerto Rico, Government Bonds were classified as Junk bonds and most of the people in the Puerto Rico are employed by the Government. The current trend is a sharp decrease in population and unemployment well above the double digits. There are hundreds of vacant homes and rents are at all time low. I have offered seller financing, made attempts to swap my house for a house, land or even an RV in the US but no luck. I can not even take the equity out by re financing since no bank in the US will make the loan. I have offered Agents $5,000 bonus on top of the commission for the sale, attempt to rent it as a vacation home, etc..  My current strategy is to buy more houses to make up for the negative ROI but it really sucks to have two properties making you no money.
I need a brilliant idea to turn this around since I have run out of them.

Answer: Wow Luis that really is a crazy situation. I think that you've been pretty innovative in trying to come up with different solutions but here are a few more that you can try out. First is to check the price. I don't know what your asking price is but often times if you just bring it down a few thousand, you might be able to pull in a buyer, even if it's just on the property that you own free & clear. Then you can use the proceeds to pay off or pay down the condo and then sell it at a discounted rate as well. Another option is to do an Absolute Auction on the free & clear property. Again, use the proceeds to pay off or pay down the condo. You could also find other landlords in the neighborhood by searching public records. Contact them to see if they are interested in purchasing both condos as a package deal. Another option for the condo is to market it to students and their parents at the college. Stress how close it is and how it makes sense for a student/parent and can even have roommates help pay the mortgage. The college might have a housing office or a campus newspaper to advertise the condo. I hope this helps. If I think about any other options I'll email/call you.  

Click Here to email me your real estate investing question

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.
This is not legal advice. Please contact an attorney for professional legal advice.




How to Determine an Income Property's Value (Q&A)

Click Here to email me your real estate investing question

Question: I've never purchased real estate as an investment before. I acquired a Quad Multifamily recently in Lowell Mass. My closing is on March 7, 2014. It took me about 5-6 months to find it. I picked this property through an MLS. While going through realtor.com, I found this property. I have an agent who sent me the MLS update daily, but it was not fast enough. I don’t think she really knows much. She does not know the concept of cash flow, cap rate and never helped evaluate a property worth for me. I am a cash flow guy. It is my priority and equity is secondary. Looking back, it was easy for me to determine cash flow, but I have a hard time determining the value of the house. For example, I don’t know if the house is selling at the market rate or has any equity. I looked over the lender appraisal report, and see how the appraiser evaluated the house worth. It is complicated. He could not find much 4-Fam in my town, so he went to towns close by the used those houses for comparison. He picked 4-Fam with similar living space and number of bed rooms.
My question is:
How do you evaluate the house worth? Is there any reliable website that I can use to determine if the house has any equity at the given sale price? I need help – step by step how to perform research and good reference websites.

Answer: Hi Chan, It’s actually very simple. When it comes to “Income Properties”, the buyer sets the value. I wouldn’t even worry about comps because there’s probably not many 4 unit properties within a 5-10 mile radius with the same square footage, amount of bedrooms & bathrooms in each unit, acreage, operating income, operating expenses, maintenance issues etc etc etc. Plus, just because the other guy didn’t do his due diligence and overpaid doesn’t mean that you have to!

I suggest finding a minimum cap rate that you are willing to except and make the offer based on that. So let’s say your minimum cap rate is 10% and you find a property on the MLS listed for $300,000. You do your due diligence and find that the property’s average net operating income is $24,000. $24,000 / $300,000 = .08 or 8% (The Cap Rate). So from here you would just adjust the offer to $240,000 to give you that 10% cap rate.

With that said, there is a big difference between $300,000 and $240,000 so before I submit that offer, I'd try to get some background info on the seller and check public records to get an estimate of how much they owe on the property to see if my offer is even feasible. Also, if you find yourself getting rejected too often, then you're probably asking for an unrealistic cap rate.

As for any helpful websites, there are many out there that will give you comps, but I don't know of any off the top of my head that will help with this method but as you see the math is actually pretty easy.
 

Click Here to email me your real estate investing question

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.

This is not legal advice. Please contact an attorney for professional legal advice.

Real Estate Negotiations (Part 8) "An Eye For an Eye"

Today's Real Estate Negotiations Tip is....

"Give Up An Eye For An Eye"

 

I believe that your initial offer should be slightly better than the lesser offer that you would actually accept. However, don't be so quick to give stuff up. Consider the seller's counter offer but if you're going to let something go, so should they. For example: If the seller wants market value for the property, you may be willing to give it to them if they're willing to hold a seller second for the difference of your offer and their offer at 0% interest and amortized over 30 years. So they'll agree to the 0% but not the 30 year amortization? Okay so lets say amortized over 15 years but they have to make repairs to the roof before closing.

 

Get the picture? Never give up something for nothing! 

Real Estate Negotiations (Part 7) "Justify Your Offer Based on Seller's Needs"

Today's Real Estate Negotiations Tip is....

"Justify Your Offer Based on Seller's Needs"

 

If you've followed the tip from my post a few days ago "Know their situation", then you should have no problem with this one. Paint a picture for them of how your offer solves their problems. At the end of the conversation, they should see a clear picture of how taking your offer will resolve their issues and bring them peace of mind. 

Real Estate Negotiations (Part 6) "Review All Options BEFORE Making An Offer"

Today's Real Estate Negotiations Tip is....

"Review All Options BEFORE Making An Offer"

 

Before you make your offer, you should step back and take some time to review all available options. Depending on the deal, you may want to come up with a cash offer (or hard money) and an owner financing offer. Doing this might even give you ideas on how to make your offer even better. After you come up with your offers take some time to put yourself in the seller's shoes. Would you take the offer or would you counter it? Also ask yourself "What would my counter offer be?" Asking these questions will better equip you to answer questions and challenge counter offers.  

Real Estate Negotiations (Part 5) "Stay In Control"

Today's Real Estate Negotiations Tip is....

"Stay In Control"

 

Negotiations can sometimes be a highly charged and emotional event. Check your emotions at the door. Never let the other party get you to a point whereas you end up losing your cool. It's just not worth it. If the other party seems to be getting emotional, or if their just demanding that you answer questions that you're not prepared to answer, it may be time to take a break. Just stop the conversation and go to the restroom or get a drink of water. Allow the conversation to have time to "reset". If this doesn't seem to be working, just call it a night. Say something like "Well I've gathered some valuable information tonight, but I've got to do a little more research before I can make/accept an offer" or "Unfortunately I have another appointment that I need to get to in 15 minutes". Maybe you need to go over some details with your partner, spouse or contractor. Bottom line, Stay in control of the negotiations at all times. Don't lose your cool, and don't let someone else bully or intimidate you into doing anything that you don't want to do.



Real Estate Negotiations (Part 4) "Know Their Situation"

Today's Real Estate Negotiation Tip is....

"Know Their Situation"

You'll find that negotiations are MUCH easier when you know the other person's situation. Knowing their situation will allow you to give on the things that matter to them but are insignificant to you. For example, a few years ago I was negotiating to purchase a property that the seller owned free & clear. I was offering to purchase the property using 100% owner financing. The seller's only hang-up was that he wanted to use the proceeds from a traditional sale to pay off a house in Florida so that he has peace of mind in knowing that if anything was to ever happen to him, his wife would be able to remain in the Florida home without worrying about a mortgage payment. Armed with that information, I offered to have him take out a term life insurance policy and I would pay the monthly premium. In exchange, he would hold a note for 100% of the purchase price at 0% interest until I either sold the property or refinanced.

Bottom line, I would have never been able to negotiate those terms if I didn't know his situation. Click here to see my post on how to find free & clear homes.

Real Estate Negotiations (Part 3) "Find The Reason"

Today's Real Estate Negotiation Tip is....

"Find The Reason"

 

The best kind of seller to buy from is a Motivated Seller. The question is.... "Why are they motivated?" It's very important to get this information out of the seller before or during your negotiations. It's generally pretty easy to get it out of them, you just have to know the right questions to ask and how to ask them. Just be straight forward, ask them "What's your situation?" or "Why are you selling?"

 

If they hesitate and try to change the subject, just let make them feel comfortable and let them know that it's easier to work out a win-win deal if you know a little more about what exactly it is that they need. After they start talking, (excuse the expression but....) SHUT UP!!! Give them a chance to tell you everything. You truly cannot structure a real win-win transaction if you don't know what the sellers need. So make sure that you always ask the right questions and find why they're selling.

 

As a bonus tip, I'd also advise that you bring your smart phone with you and if the seller consents to it, record the conversation. This will give you the opportunity to go back later and see if you missed anything.

Real Estate Negotiations (Part 2) "Know What You Want"

Today's Negotiation tip is....

"Know What You Want"

There are  many different strategies to investing in real estate. If you've found a property that you're interested in purchasing, you should first know what you want to do with that property before you begin negotiations. If you're planning to buy-&-hold this property using owner financing, then you can probably influence the seller to give you the terms that you want (such as 0% interest) by offering a higher purchase price. If you're preferred strategy is flipping houses, then you're primary goal is to buy that property for as little as possible so you can't offer the seller more money, but you can offer a super fast closing by either paying with cash, or using a hard money lender.

To be a successful negotiator, you must understand and think through what you want to accomplish in the negotiation. One great way to do this is to take the time to write out a list of questions that you can ask the seller. The answers will give you the knowledge of how to successfully get exactly what you want and need. 

Real Estate Negotiations (Part 1)

Negotiating is a necessary skill in real estate investing. Without it, you will find yourself overpaying for properties, contractors and even giving away too much equity on your partnership deals.  I actually love negotiating and quite frankly…. I think I’m pretty good at it. That’s why I decided to start this series on the topic. I don’t know exactly how long it will be but I just want to give my readers a leg up on their opposers.  So here’s my first tip….

 

"He who NEEDS most, loses" - Every negotiation starts with a Need and a Desire. If you're working on a particular deal, ask yourself, "Do the sellers need to sell or do they merely want to sell?" You will definitely workout a better deal for yourself if the sellers need to sell the property. On the flip side, you must ask yourself the same question. "Do I need this deal to workout, or do I merely want it to work?" If you feel that you need to buy this property for whatever reason, then you really should check yourself out to see if there are any alternative resolutions to your problem before you agree to anything. You certainly don't want to put yourself in a position that you'll regret down the road. Remember, you're an investor, you should only invest if the numbers work in your favor.

Bottomline.... Always be in the strongest negotiation position!