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Wednesday, June 20, 2012

Swing Batter, Batter Swing!

As of July 29th, 2012 I will have been purchasing properties for 10 years. Although my first acquisition was a personal residence (which I would highly recommend new investors not do!), I knew while buying it, eventually it would become a rental property for me. I still own that property and it has produced excellent cash flow ever since I moved out of it.

Even though I was buying mainly rental houses over the next few years, I didn't start investing full time until 28 August 2006 when I purchased my first property to rehab and flip from a wholesaler. Since that time, in the last (almost) six years, the markets have gone crazy. I got started doing rehabs and flips when the market was crumbling all around. Before I jumped in, I was inspired by many, many investors. Some were doing a lot of deals. Some were doing BIG deals. Some were making huge piles of cash and living extravagant lifestyles with their new found wealth. I was in awe. I was intimidated. I didn't let it stop me though. My first deal produced approximately $26,000 in profits in 6 weeks. I was hooked. I wanted more. I kept buying and flipping properties. The odd thing was that most of the investors around me started playing it much safer while I was getting more aggressive. It actually became very easy for me to get wholesale deals to rehab. I remember my mantra back then was, "Buy lower and sell below ARV fast!"

It culminated with me buying a 4,126 Sq/ft property on a hill top for just over $700,000. I was going to fix and flip it for a huge profit. I'd show em all! Well, things didn't work out quite like I thought. I ended up holding that property for almost 10 months and the market was getting worse every day. When I finally sold the property (for a profit!), the majority of the investors that used to show up at our networking lunch had disappeared. There was still a hardcore small group, but most weren't buying anything. I think we spent more time talking about the books we were reading than the deals we were doing.

Over those couple of years, I had made quite a few mistakes. Only one cost me any significant amount of money, but it didn't set me back much. Eventually, I decided to rethink my investing strategy and focus. My new goal was to come into the office and hit just a single or a double. If I could put a few good houses into escrow every month, month after month, and do it in a way that wasn't dependent on what the market was doing and so I wasn't putting myself into a highly leveraged, financially risky situation, I knew I could develop a long term business model that would provide for me as long as I wanted to keep showing up and pressing the buttons.

10 years later and I'm still here. I see many new, younger investors hitting their triples, and home runs, constantly stepping it up to go bigger and better on their deals. I imagine just like when the market shifted last time, many of them will quietly disappear as their over head eats up their cash flow when they can't figure out where the cheese has been moved to. A new quote I got from Mike Cantu that I keep written on my yellow pad states, "Take care of today's cash flow needs and build reserves." I think that is a really good quote. Mike has the best business acumen of anyone I have ever personally met.

I hit the gym 4-5 times a week. I sleep till 10AM. I work about 5 hours a day, 4 days a week. I have perfected my buying systems. Singles and doubles is all I'm swinging for. A nice triple every once in a while is great and I've had a few home runs over the years. Still waiting on that grand slam, but the destination isn't as sweet as the journey... so I'm told.

This week I wholesaled a house and split that fee with a friend I met on Facebook, but I have never met him in person. I purchased 2 houses next door to each other for 58% of ARV. They both have long term tenants and I plan on holding the properties as rentals. I got an offer for a rehab / flip I just completed and I haven't even put it on the market yet. I countered their offer and pushed the buyer up another $10K which they accepted. I should net right around $80K on that property. In my world that is a good triple base hit. I purchased another house in Apple Valley that I intend to do a light rehab on and sell As-Is for 85-90% of ARV which should net around $20K. And finally, I leased up one of my rentals to a new tenant paying me a few hundred dollars more than the last tenant.

When you get up to bat, what are you swinging for and how long is your strategy going to keep you in the game?

I'm taking Friday-Monday off and going out to see the sequoias. A few interesting facts about the sequoias; they are the fastest growing tree on earth, their roots only go down about 3' deep, and their wood is very brittle. It is the combination of the brittle wood, shallow root structure, and their top heaviness that eventually causes them to be blown over by wind. You can learn a lot about business from a 3,000 year old tree! I've always wanted to see them and haven't made the time until now, and quite frankly,  I'm more excited about that trip and the time away from my office than any of the deals I've done this week.

What does your "root structure" look like? Are you top heavy with flip deals, but have shallow cash flow?

Tuesday, May 29, 2012

Making Smart Financial Decisions at the End of Your Days

I spoke with an elderly seller before the 3 day weekend. Her husband left her a single family house she rents out in the high desert, not a particularly secure place to own rentals. I made her a cash offer of $40,000. She said she could not possibly accept such an offer because the house was her only source of income for her retirement. I asked if she might consider carrying a note on the property. After slowly explaining what I meant, she wanted to know what kind of offer I might consider giving her.

I told her I would be willing to double my cash offer price, if she would carry paper and give me terms that allowed the tenant to cover the mortgage, pay all the expenses, and put a little profit in my pocket every month. It is currently rented at $950/month. Let's take a look at the numbers based on the current rent:

Monthly Rent: $950
Monthly Expenses: 40% or $380
Required Minimum Monthly Cash Flow to Investor: $150
Remainder Available for Debt Service: $950 - $380 - $150 = $420
Purchase price: $80,000
Down: $5,000
Principal Balance: $75,000
Interest Rate: 4%
Monthly P&I Payment: -$420
Solve For Term: 272 Months or 22.5 years

If the seller accepts my terms offer, she can collect $420/month for the next 22.5 years without worrying about any loss of income due to vacancy or repairs and she gets $5,000 today to put in the bank providing her with some security for any expenses that might come up. She could also sell the note at any point in the future for an immediate cash payment if needed.

She said she needed to talk to her CPA and financial adviser, so I followed up with her after the 3 day weekend. The seller said she could not accept my terms offer because both her CPA and financial adviser said it is not in her best interest to carry paper at her age. They both claim it would be better for her to sell and take the cash. In this market, her house is only worth about $80,000 out of which she will have to pay commission and sales expenses. Let's assume they eat up 10% of her gross, or about $8,000 leaving her with $72,000 for her pocket. She won't have any capital gains tax or depreciation recapture because she purchased the house new for $115,000.

If she takes the $72,000 from the cash sale and puts it into a savings account, we can safely say that inflation will wipe out any interest she might earn on the savings. If she took that same $420 a month faithfully, her money will last approximately 171 months, or 14 years. More than likely, she will dip into that $72,000 on more than one occasion giving her a lot less than 14 years.

Shortly afterwards, I spoke with an 87 year old seller who owns 5 houses all next door to each other. During the conversation, I heard a clue that he would carry paper. When I asked, he said he would love to carry paper and would be willing to take nothing down. Why do I have two sellers in similar situations, but one is more than happy to carry a note and the other terrified of running out of money? Do you think the CPA and financial adviser really have the first seller's best interest at heart by telling her to take the cash?


Monday, April 2, 2012

Buying Occupied Properties

I buy a lot of occupied properties. However, I wholesale the majority of these and haven't had to deal with the tenants. There were only three instances in the past when I purchased a property with a tenant/owner in place and did not wholesale it.

- Western: I purchased this property from a wholesaler. The mother of the two sons who sold the property was to stay in the home for 60 days and pay rent. This is commonly referred to as a sale lease back. However, she only paid the first month's rent and didn't pay after that. I filed eviction, but she moved out shortly afterwards. There was a storage unit at the back of the garage in which she left behind her mother's living room set. It consisted of two antique marble top end tables and a matching coffee table which are now in my living room, and a very old, but very nice couch and chair which are sitting in my warehouse. 

 - Mojave: I purchased this property from a wholesaler. The owner was still living in the home and after my experience with Wallace, I wanted to be sure he would move out in a timely manner. I asked the wholesaler to offer me some sort of protection and some way to get the seller motivated to move out. He had the seller sign an addendum that stated $10,000 out of the proceeds would be held in escrow. If the seller did not move out within 7 days after close of escrow, there would be an automatic $2,500 extension fee and $250 a day penalty thereafter. I made an extra $5,500 on that deal because it took the seller 12 days to vacate the home.

- Wallace: I also purchased this house from a wholesaler. It was sold by two brothers as well. One of the brothers was to stay in the house and pay rent. The 1st of the month came around and he didn't pay. I went to see him and he said he didn't have any money. I could only laugh because I had just paid over $200K for the property. I filed eviction on him and it went all the way to the sheriff needing to come out for the lock out. He was gone on that day and the property was cleaned out. I called his brother and let him know what happened, and how much I was owed. His brother paid me in full out of his brother's share of the proceeds.

I recently purchased a property in Corona. It is located in a very nice neighborhood just around the corner from an elementary school. I decided to rehab and flip this property. As with almost every real estate deal, we do have a challenge: The current occupant is a non-paying tenant. He hasn't paid rent in seven months. At first, he said he was interested in buying the house. I liked the idea of that because it would mean I get to move the rehab budget to the profit line, but I didn't think he would qualify for a loan. I sent him over to my preferred loan broker and she told me the only thing he would qualify for was a bankruptcy!

Now we have to make a decision on how to best proceed with getting him out. We definitely do not want him filing a BK. We do have a copy of the rental agreement he signed with the former owner. The problem here is the change in terms without a 30 day notice. Per his agreement, rent is to be paid at the former owner's address. Now we want him to pay rent to our address. If we put our address on the 3 day notice to pay or quit, he could argue in court about the change in terms and get the case thrown out. Ideally, avoiding a court situation is best for all parties involved.

We called the local eviction attorney and asked what he thought we should do. His suggestion was to serve the tenant with a Notice of Voluntary Transfer which is a 60 day notice to move. We then called the tenant on Friday and let him know rent would be due on the 1st per his rental agreement. If he paid the $1,600, we didn't expect him to, we would serve him with a 60 day notice to move. He had been there over 12 months and 60 days is required per California law. He said he wanted proof of transfer before he paid.

What we decided to do: We then told him if he didn't pay, we would stop by on Monday and serve him with a 3 day. When we went by on Monday morning, we brought the 60 day notice, a copy of the deed, and the 3 day notice to pay. We got there at 11AM and he was home cooking breakfast! We kept it very friendly. We handed him the deed explaining who the new owner is, we then gave him the 60 day notice to move out, and finally, the 3 day notice to pay or quit since he had not paid rent on the first and it was now the 2nd.

We then made the tenant an offer: I told him I spoke with the owner and explained that he (the tenant) is a really nice guy caught up in a bad situation and could he (the owner) give him some move out money. The owner agreed to give him $1,500 cash, in $100 bills, if he was out by Sunday the 15th, $1,000 if he was out by Sunday the 22nd, and would file eviction on Monday the 23rd with no cash payment. The tenant was very happy to hear this. Since I was at the door and got him thinking we were on his side, I asked if he wouldn't mind if we came in and looked around. He obliged and gave us a tour.

Our hard money loan on this property is $1,000 / month. Eviction would cost at least $600. The tenant has bad credit and obviously no job. If we tried to strong arm him, he could file BK and drag this out for months. If he stayed for even 2 months it would cost us $2,000 in holding fees and $600 in eviction fees, and we don't even know how long before we could actually get him out or what condition the house would be in by the time he vacated. Making him an offer we don't think he can afford to pass up and 'going to bat' for him against the owner, we think we can get him out quickly, keep the property in great shape, and at the minimum expense to us.

By getting inside, we got a good idea of our rehab budget, noticed he had bagged up a lot of his clothes, and there were 'Moving Sale' signs sitting on the kitchen table - a good indication that he will be out in a timely manner.

Friday, March 2, 2012

When It Gets to 'Yes', It's Not About the Money...


The REO market and trustee’s sales are where everyone seems to be playing these days, but I have always followed the rule "Do what nobody else is doing." Also, I enjoy talking to people-sellers and helping to solve their difficult real estate problems. I specialize in buying subject to existing mortgages or using purchase money financing (structuring a terms offer). Most of the properties I buy are in some state of disrepair and I love the major fixers. I really enjoy the challenge of turning a pre-condemned property into a big fat check. Where the city and neighbors only see blight, I see profits!

The one thing that I have learned in dealing with thousands of vacant or tenant occupied property sellers is that just because the owners do not live in the area and the property is not producing income or not producing consistent income, it doesn’t necessarily mean there is a deal to be made. Almost daily, I get suspect leads from new investors asking me to help them negotiate a deal, but in reality they are just badgering a non-motivated seller to death trying to create a deal out of nothing. You all have heard that old saying, "you can't squeeze blood from a stone." Well, you can't squeeze equity from a non-deal either.

A vacant, free & clear house typically means the owners purchased it many, many years ago and because of Prop 13 (here in California) they now pay very little taxes every year. To many people, paying a few hundred a year in taxes is much more convenient than dealing with a tenant for the income. They still get the depreciation write off! Where I come into play is when we have the same situation, but there is some other element which some investors call the hot button or motivation, but my preferred term which was given to me by my friend and fellow investor Rick Harmon, is the catalyst. Just like a chemical reaction, nothing happens until a catalyst is present. A seller will not part with a house in a down market unless there is a catalyst precipitating an event or situation which cannot be easily solved by the owners such as major repairs, need for quick cash or income, relief from management, code enforcement issues, or the need to sell and feeling embarrassed about the current condition.

When the catalyst is present it still does not ensure a deal. I need to get the seller to recognize that I have the solution to their problem and that I am the best choice. In negotiation, the other party has to believe you have the power to harm or to help them. When pre-screening sellers, look for the catalyst from the moment you make contact. Ask questions and listen. If there is no catalyst, make your offer and move on. The upside to this situation is that life happens to us all and I would put this seller on a consistent follow up program. A stale lead today can turn out to be very profitable in the near future. The favorite saying in our office is, "Time and circumstances changes all seller's minds." 

Wednesday, February 15, 2012

Rental Property Cash Flow Analysis

I recently saw a question on a forum that asked, "What percent of positive cash flow do you want on a rental?"

I'm not a big fan of percentages or yields when it comes to investing in single family houses. Reason being, most investors talk yield, but it is on such small amounts of money, a daily trip to Starbucks would wipe out all the profit. Therefore, I don't have a percentage for you, but in my office, we shoot for $300-$400 per door. I just can't get that excited about dealing with a tenant for $200 or less a month. The only way I would consider less money is if the financing is extremely favorable, such as zero interest. However, even on those zero interest deals that I have negotiated, I am still going to get my $300+ / month cash flow. We just put together a $60,000 seller carry back on a $70,000 house. No money down, no interest, and this little 2 bedroom house will still generate $340 a month in cash flow once it is rented.

I talk to so many investors who think they are making money because they use 30-40% for expenses (taxes, insurance, vacancy, repairs, management or overhead). Too many new investors leave that last one out. They think it is free to drive out to their properties and do inspections, lease ups, put signs up, type up and run ads. Big mistake!

40% is even too low. One large capital expenditure and all of the cash flow for 2-3 years is wiped out. I think the best number to use is 50% for expenses. I have a friend who owns over 100 houses and has managed those same houses for 20+ years. He told me his expenses run about 44% over the long term. Everything seems fine and dandy until that roof needs to be replaced, a water heater fails, tree roots destroy the sewer line, and don't forget about those lovely 'acts of god'. I just had a tree branch crash down on a roof and the HOA fixed the outside, but said the inside was my problem. That is when you discover if you have been budgeting for repairs or pocketing the money and calling it cash flow.

After you lop off 50% of your gross collected rent for your expenses, you still need to deduct out what your financing costs are from the remainder 50%. Whatever is leftover after financing is your real cash flow (which you  may still have to pay taxes on!). If you make the decision to join us lunatic landlords and hold a house instead of flipping it for a big fat check, shoot for a minimum $300-$400 per unit on your average rental property and you'll be a much happier lunatic. Otherwise, you may get one of my marketing pieces and decide to call me to get you out of the trap.

I don't like yields when investing in SFR. The numbers are just too small to waste time punching them into a calculator. If you claim you get a 20% COC (cash on cash) return, but you only have $15K into the house, you are making a whopping $3,000 a year. Trust me, $250 a month isn't worth the thrill of management and the loss of your $15,000. Especially if the underlying financing isn't 100% amortized! Too much risk for way too little cash flow. There are much easier ways to make an extra $250 a month without having to deal with a tenant and maintenance and keep your $15,000 cash in your pocket. Now, if you are consistently getting 20%+ on your $500K, you are starting to grab my attention and we should schedule a dinner, not lunch. (Your treat though since you're making all that loot!)

Not that I'm down on rental properties. A lot of my friends have become exceptionally wealthy holding houses. But in this market, it doesn't make much sense for me to do so. I wholesale almost all properties that come across my desk. I'd rather have $5,000-$25,000 in cash today than a $300 a month income and a long term liability with some short term financing. Until better financing options are available, or unless I negotiate favorable seller financing terms, that property is off to escrow and I'll be looking for my check. Next!

Just off the top of my head, I cannot think of one single family house investor billionaire. Coincidence?