SMARTERLANDLORDING

ADVICE FROM EXPERIENCE

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Is Your Real Estate Market A Good Place To Start?

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Blogger’s Note – The son of a good friend of mine is looking to get started in real estate investing.  He would like to become a landlord and find properties that offer positive cashflow to replace his current income.  His goal is to ultimately become a full time real estate investor.  I have been giving him some advice as he tries to liftoff his real estate investing and I thought it would be interesting to share some of his questions and my answers on this blog as I’m sure there are others out there who have the same questions.  I hope to publish more questions and answers in the future.

Question – How do I know the area I’m looking in is even a good place to start?

Answer – By doing some research.

My friend’s son is wondering if his local real estate market will provide positive cash flow.  This is a very astute question to ask as every market is different and not all markets will provide positive cashflow.  The only way to get to an answer of his question is by doing some research on his local real estate market.  This post will hopefully serve as a guide for him in that research.

What Is Positive Cashflow?

To start, let’s define what positive cashflow is so everyone is clear. Positive cashflow is what remains after subtracting all expenses from income.  It equals gross rents, less principal, interest, taxes, insurance, repairs and maintenance, utilities, vacancy credit and reserves credit.  It is your profit.

To determine if the market you want to work in will provide positive cashflow you need to do some research and put all of those numbers together.

What Types Of Properties Are In Your Market?

First, look around to see what types of properties are in your particular market.  Does it consist only of single family homes?  Perhaps there are townhouses and duplexes available or even small apartment buildings.  Whatever properties abound in your area, these are likely what you will be investing in, so focusing on that type of property is a wise place to start.

Next, determine what those properties are renting for in your market.  What will a 3 bedroom/ 2 bath home rent for per month?  What will a 2 bedroom/1 bath unit in a duplex rent for per month?  What about a one bedroom apartment?   Look at whatever happens to be a typical property in your market.  Search websites like Zillow.com and Rent-o-Meter.com to get an idea on these rental rates.  Then look for websites of local property managers as they will often have local listings as well.  As you are out and about, also call and inquire on for rent signs.

You will likely find that there is a range of rents for particular properties in your market.  Drill down in your research to try and find out why that range exists.  Is it the property location?  Is it the property condition?  Look at pictures on the websites you research to examine property condition.  You will often find that better looking and updated properties command more rent.

What Are The Sales In Your Market?

Once you have an idea of the rent range in your market, the next step is to examine what these types of properties are selling for.  Try to look at recent sales, say the last six months or so, as well as what is currently on the market.  Again Zillow.com is a great resource here as is Realtor.com.  To find recent sales, you may need to dig a little deeper but the information is out there.  Keep in mind however that you are looking at listed prices on the retail market and they are often the highest prices out there.  But they are a good place to start to get to know your market.

Once you have these two numbers, rent range and retail selling prices, you can begin to determine how your market will fare in terms of cashflow.  So grab pencil and paper and let’s put things together.

Putting It Together

On the top of your paper, write the property address and then the expected amount of total monthly rent you have determined from your research.  From there, subtract your expected expenses to determine if there is any cashflow.

  • Subtract the monthly principal and interest payment based on the projected sales price, how much you will need to borrow and interest rates.
  • Subtract the monthly property tax payment which can likely be found on your local property tax assessor’s website.
  • Subtract a monthly property insurance payment. Find this out by talking with local insurance agents in your market.
  • Subtract repairs and maintenance which are typically 10% of total monthly rents.
  • Subtract any utilities you may need to pay (these will be unlikely on a single family home and more likely on multiple unit properties).
  • Subtract a vacancy allowance of 10% of the monthly rent.
  • Subtract a reserve credit of at least 5% of monthly rent to set aside for future repairs.

Hopefully after all of that subtracting there is some money left over.  That is your positive cashflow.  If there is no money left over then the property, at that price, will have a negative cashflow.  Play with the price, and thus the principal and interest payments a bit, to determine what price will generate positive cashflow.

Now repeat this process again and again and again for other properties.  Once you do this process several times, you will have a pretty good idea of the potential for cashflow in your market.

Remember though that you are looking at retail prices of what is listed on the market.  If you do not find any properties with positive cashflow that does not mean you cannot get it.  You may have to search for it in properties that are not on the market.  But that is a topic for another post.

For now, go do some homework and research the numbers I have discussed.  See what you find and then go from there.

Does anyone else have some advice for someone wondering if their market is a good place to start?  If so, please share it with a comment.

Work On Your Business, Not In It

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When I started out as a landlord, I believed that it was much more sensible for me to be cutting the grass, fixing kitchen sinks and painting walls.  In other words, I believed that working in my business was a much better use of my time than working on my business.

The exact opposite is true.

How many deals did I miss because my head was under the kitchen sink?  How much cashflow have I missed out on because I was cutting grass?

I will never really know, but hopefully I can help you not make the same mistakes.  So check out this short video about working on your business, not in it.

As I said in the video, I got a new camera for my birthday so I am trying out some new ideas for content here at Smarterlandlording.com.  Let me know what you think or if you have any ideas for future videos with your comments. 

First Time Landlord Surprises

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There is no teacher like experience.  To truly understand anything in life, you just have to jump in and do it.  Being a landlord is no exception.  Jumping in however always leads to things you were not expecting, things that surprise or perhaps even shock you.  What surprised me when I jumped into landlording?  Here are five first time landlord surprises that opened my eyes.

  1. People Are Not As Put Together As You Think – Outward appearances are very deceiving and once you become a real estate investor and a landlord, the curtain that people live behind often gets blown away. As an investor or landlord, you see the credit reports, the empty vodka bottles, the clutter, filth and the chaos.  Disorder in other’s lives is much more common than you think it is.  It is often the reason that real estate deals can be made.  Get ready for it.
  2. Repairs Never Stop – Before I became a landlord, I rented apartments; I owned a house and a car; I had appliances and yes things broke some of the time. But it sure seems that the breakage ramped up when I got on this side of things.  I can remember being incensed that every time I turned around something else was broken and that I would have to spend more money.  I’ve gotten over than feeling.  Things never stop breaking in this business and your tenants are just not going to care for things as well as you might (see number 1 above).  The experts say to figure on ten percent of gross rents going towards repairs.  But it sure seems like it is a lot more sometimes.
  3. Deceit Is Very Prevalent – People lie. I knew that before I became a real estate investor but I did not realize how much.  Once that curtain is pulled away you will see how much the truth is stretched.  Tenants, property owners, realtors, contractors and government officials all lie.  Not all of them all the time, but enough that I was surprised.  At first I was naive enough to often believe the lies. Now, I’ve been in the business to long and have gotten pretty good at calling people out.
  4.  A Lot Of Strong Will Is Needed – As investors and landlords, we want to keep the money flowing in, keep our properties in good shape and keep the new deals coming.  All of that takes a lot more effort and force of will than anyone ever told me it would.  It is simply amazing how people will not and do not want to do what they are supposed to do or say they will do.
  5. You Will Be Viewed With Suspicion – This one really surprised me. Sure I expected tenants and other property owners to be somewhat cautious, but almost everyone I tell that I am a real estate investor and landlord seems to view me with instant suspicion.  I can see it in their eyes.  Not a lot, but just a hint.  I have no idea what everyone is so suspicious about or where this suspicion comes from, but this is perhaps one of the most surprising things about becoming an investor and it continues to this day.

Should these surprises keep you from real estate investing?  No I do not think so.  They are just challenges that need to be faced as with anything in life.  Hopefully now you will not be as surprised as I was as you go forward in your investing career.

What surprised you about real estate investing?  What were you not expecting?  Do you agree with my surprises?  Let me know with your comments.

How Did Your Summer End?

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August and the traditional end of the summer season has come and gone.  While I am sure many of us were out enjoying the last long holiday weekend of summer, it looks like a few of us landlords might have had a frustrating weekend as the posts, “When Tenants Overstay Their Lease”  and “My Tenant Is Running A Business”  received plenty of hits in the last week.

On the other hand, things may be looking up for some landlords as another very popular post over the past week was “Is Your Rent Increase Legal?”

Hopefully your Labor Day weekend was filled with more ups than downs.  If not, cheer up.  It is September, fall is right around the corner and “The Autumn Leaves Mean Deals.”

Things I Wish I Knew Before I Bought My First Rental Property

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It is hard for me to believe that it has been almost 15 years since I bought my first rental property.  Since then I have become much wiser (and older), but looking back I am still glad I got into real estate.  Real estate has provided me with everything I need and more.

It is always kind of fun though to look back and think what you would have done had you had the knowledge you have now.  Hindsight is of course 20/20, but what would I change if I could go back in time?  What do I wish I knew then that I know now?

I Was Paying Too Much

Almost every real estate investor I have met has said they paid too much for their first investment property.  I guess we simply did not fully know what we were doing.  My first property was not a bad investment, but I did pay close to a retail price for it.  I also wanted to live in one of the units and was moving from out of state so I was looking for something decent in a decent area and that can sort of blind you.

Looking back, I simply had a lack of knowledge, experience and other investors to bounce ideas off of.  I really had no good way to know.  Local REIA’s were the way to go back then and I had not really invested the time in that group I needed to yet.  Today I think things are a bit easier with all of the information, blogs and forums out there on the internet.   All of that was just getting started back them

I still own the property today even though I do not live there anymore. It performs well.  But it could have been much better.  The lessons learned were to no rush into a decision and to get to know your market better.

I Needed Help

Back then I thought I would (and could) do everything myself.  This included cutting the grass, making repairs and keeping the books.  I should have let all of that go and focused more on my business rather than the little stuff in my business.  I should have hired people to do more of those things because if I had had more time then I could have focused more on my business.  Looking back one of my main regrets is that I did not hire more people more quickly to help me grow my business.

The lesson here is to hire more help.  You are not saving money by doing things yourself.  It is actually costing you money because you are not growing your business.

Real Estate Investing Is A Business

This aspect of real estate investing had just had not sunk in yet.  I thought I was just going to be a landlord and the materials I was studying were all about landlording.  But I needed to also be studying and learning about business.  Because by buying rental properties I was not only becoming a landlord, I was starting a business.  Unfortunately I did not really think of my rental properties as a business until sometime later.  If I had thought of my rental properties as a business and worked harder on my business I would have been able to do a lot more.

I Should Buy More!

Even though we here in Memphis are not in a high price appreciation market, real estate was cheaper back then and there was a lot less competition around.  If I had been smarter, I would have bought and bought and bought.  Once I had gotten my feet wet and gotten a feel for what I was doing I should have expanded a bit more.  I did eventually but I guess I had to live and learn.  The lesson here is that the old adage “don’t wait to buy real estate, buy real estate and wait” really is true.

The Takeaway

Get into real estate today.  Do it while hiring people to help you and do not try to do it all yourself.  Think of things as a business from the get go.  Looking back fifteen years from now, you will be glad you did.

What do you wish you knew then that you know now?  Please share with your comments.

Tenants Can Retaliate So Choose Your Battles Wisely

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This story from Buffalo came across my news feed the other day and I thought it would make a good introduction to a post.  In the story, a tenant and his landlord apparently ended up in a very adversarial relationship.  The tenant damaged the landlord’s car, the landlord had the tenant arrested and the tenant then proceeded to wreck the landlord’s property causing thousands of dollars in damage.

I am sure there is much more to the story than the snippet reported in the link, but the story helps to demonstrate some good points that we landlords need to remember.  Tenants can retaliate and cause a lot of damage.  We therefore need to do our best keep our relationships with our tenants on a professional level.  And we need to choose our battles wisely.

Tenants Control A Valuable Asset

Our tenants occupy some very expensive and easily damageable assets, our property.  If they get it in their head that they want to cause us harm, then they very well can and will.  There is simply no way that we landlords can guard and protect our properties 100% of the time.  Sure, you can sue and you might get a judgment against them, but good luck collecting it and who wants the hassle of going to court and repairing a destroyed property.  It therefore makes a lot of sense for us to do what we can to keep our tenants from taking things personally.

Sometimes however that can be a very difficult thing to do.

Tenants can and will do crazy things.  Tenants will hide stuff from you.  They will paint the walls purple.  They will not pay the agreed upon rent and then tell every lie in the book to try to get out of it.  It can all make you want to scream just throw their butts out on the street.

Keep Your Cool

Do not let the professional relationship with your tenant spiral out of control.  And do not let them get the best of you.  There is just too much money, property and emotions on the table to allow that to happen.  It may take a humongous effort on your part, but here is what you must do if a tenant starts to become unreasonable or emotional and tries to escalate matters.

  • Keep Calm – You have all seen those trendy British posters. You need to follow their advice and keep calm.  An angry mind will make stupid decisions.  Do not put yourself in a position to make stupid decisions.
  • Keep Things Professional – Always keep things on a professional and businesslike level, even if your tenant is yelling at you. Cite company policy and the house rules.
  • Keep Your Voice Down – Never ever get into a shouting match. Nothing good will come of that.  If you have to, just….
  • Walk Away – Remove yourself from the situation to let things cool off. If you feel your temperature rising and you think you are going to blow, it is best for you to remove yourself from the situation before things get askew.
  • Do Not Take It Personally – It is hard not to sometimes, but just remember that these are business decisions and people lash out at others associated with those business decisions.

Now, I am not saying that you do not need to defend yourself, your reputation and your property.  Nor am I saying that you should not bring the hammer down when it needs to be brought down.  What I am saying is your tenants control a significant asset of yours and they can quickly do a significant amount of damage to it if they feel wronged.  They can and will retaliate against your property if you handle a situation poorly.  It has happened to me and it has happened to many other landlords I know.  So the thing is to not make them feel like you have wronged them, even if you are demanding rent and evicting them.  And you cannot do that if you get angry or let them dictate when and how the battle is fought.

Choose Your Battle

Remember, you can get into a screaming match with your tenant, or you can calmly walk away and go back to your office then call your attorney and file for eviction.  In this way, you choose the timing of the battle and how it is fought, not your tenant.

The Smarterlandlord knows not to let their tenants get the better of them.  They know when to walk away and they know how and when to pick their battles.   They understand that ultimately they will have the upper hand, and that they can make even the biggest problem go away eventually.  But they also know they have to be careful and remove that problem in a way that will not cost them so dearly on the back end.  It does not always work, but when you choose wisely, it will work most of the time.

 

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The Pump and Dump Scam

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Below is a short clip from Episode 11 of The Smarterlandlording Podcast – Buying, Rehabbing and Managing Class D Properties.   In the clip, Erik Nowacki and I discuss the “pump and dump” real estate scam.

Some deals look great on paper, but the reality is that you are being scammed and really just buying a pile of trash.  You do not want to get caught up in a pump and dump scheme, so give the clip a watch to find out what it is.  Listen to the full podcast episode of my interview with Erik and find out how to protect yourself when buying these types of properties.   You can listen to or download every episode of The Smarterlandlording Podcast here.

How To Work Backwards From The Rent To Determine Cashflow

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My previous post examined the components of a cashflow analysis by working backwards from the rent.  In this post, I want to put all of those components together by using examples in order to help you understand the analysis process and determine cashflow.

The goal here is to and apply the cashflow analysis components to practical examples so you can do two things.  One, determine if the asking price on a property is anywhere near your criteria for a good deal.  Two, develop an offer price on a property that may not be listed.  Both of these numbers will be arrived at by working backwards from the rent.

In order to develop these examples, I am going to “meld” several properties together from the area of Memphis, TN that I generally work in.  This area has a strong rental market and is in a nicer part of town.  So rents will be on the higher end, but so will prices. The numbers are however typical for the area.  However, the analysis will work for any property anywhere.

Let’s Begin.

We will look at two duplexes.  One currently on the market, listed in the MLS by a Realtor and being offered for $195,000.   The other is an off market deal in which the owner has asked you to make an offer.   Is $195,000 anywhere close to a deal?  What should you offer to the owner of the second property?

The Market Listing

The first thing we have to know about any property is the potential gross rent.  What is the amount of rental income the property will bring in each month?  After doing some research, you find that each side of this duplex will could bring as much as $750 per month or $1,500 total gross monthly rent.  This is the first number you need for the analysis.

Now Work Backwards

First, go to the Shelby County Property Assessor’s website to look up property tax information.  Here you can enter an address and get both the appraised and assessed value.  Understand that duplexes in Tennessee that are non-owner occupied are assessed at 40% of appraisal, rather than the 25% rate for owner occupied properties. The amount of tax will therefore be higher than it would for a single family home of similar appraised value.  Keep quirks like this in mind when looking in your area.

On the Property Assessor’s website we can also calculate the yearly amount of taxes.  Upon doing so we find that the total yearly tax bill for this property (which is appraised at $150,000) is about $4,200 or $350 per month.  This is the second umber you write on your sheet.

The third is the monthly insurance premium.  After talking with your insurance agent you find that your yearly insurance premium will be $480 or $40 per month .

The third, fourth and fifth numbers to write down are easy.  Simply take out 10% from the gross monthly rental income for maintenance, vacancy and reserves.  These numbers total $150 each.

So this is where we are at so far.

Property A – Listed Duplex – $199,000

Gross Monthly Rental Income                                 $1,500

Less Property Taxes                                                    $350

Less Property Insurance                                            $40

Less Maintenance                                                       $150

Less Vacancy                                                               $150

Less Reserves                                                              $150

Remaining Balance                                                    $660

Now we need to add in the cost of using other people’s money.

Most likely, you are not going to have a spare $199,000 laying around to pay for this duplex.  You are going to need to borrow that money and there is a cost for that, which is interest.  You have to pay the money back along with interest every single month.  This principal and interest payment is the last number we need for the analysis.

Let’s assume you are looking at your first or second deal and can get very good terms from a local bank.  Terms that are similar to terms anyone else would get if they were buying their own home.  As of this writing, interest rates are around 4.7% for a 30 year fixed rate mortgage.  If you put 20% of $199,000 down ($40,000 for ease) on this particular property and thus borrowed $159,999 your monthly payment would be $829.82.  You can adjust the amounts you borrow and other terms and calculate your monthly payment here.

After subtracting all of the expenses from the rental income, this property has negative cashflow.  There is no deal here for you.  This scenario is often the case here.  That is just where the market for these types of properties are.  The owner is likely hoping to sell on the retail market to an owner occupant looking for a little income.

The Unlisted Duplex

What about the second property?  The one you found and are dealing directly with the owner.  What price can you offer?  To find out, do the same analysis, but play with the principal and interest payment a bit.

On this second property, let’s assume it’s a little bigger, and the gross monthly income is $2,000.  Let’s run the same analysis.

Property B – Unlisted Duplex – $???

Gross Monthly Rental Income                                    $2,000

Less Property Taxes (Higher appraisal too)              $400

Less Property Insurance                                              $40

Less Maintenance                                                         $200

Less Vacancy                                                                 $200

Less Reserves                                                                $200

Remaining Balance                                                      $960

This property is looking a little better than the first one as there is still almost $1,000 per month cashflow before we look at the cost of using other people’s money.   Let’s keep in mind that we are looking for at least $100 of cashflow per unit or $200 per month.   That means you can afford to have a principal and interest payment of around $750 and still achieve your cashflow goals

Using the same criteria I used for the first example and assuming you put 20% down, the most you can offer for this property is around $175,000 as the monthly payment on $140,000 is just under $750.

Will the owner take that offer?  Maybe.  But I would start out with a lower offer, perhaps around $150,000 or so and see what the owner does.  If you never ask, you never get.  Plus, the owner might just take it.  If not, perhaps something creative can be worked out.

It Can Be Hard To Find A Good Deal

Both of these examples demonstrate an easy way to calculate cashflow.  Sometimes it can be hard to find good cashflow, especially in strong markets.  Be aware that I did not add any money for repairs and also assumed you would manage the property yourself, so no management fees either.  Many times, to find good deals you really have to dig deep or go into marginal areas where there is more risk.

Despite the examples I used, Memphis is a strong cashflow town.  What about your market?  Please share with your comments.

Work Backwards From The Rent

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The real estate market is pretty hot right now, but deals can still be found.  How can you tell?  There is no one size fits all answer.  Nor is there a set formula because everyone and every piece of real estate differs.  The best way to determine a deal is to work backwards from the rent.

Investment properties are investment properties because they generate some type of income.  For our discussion here, I want to focus on rental income for the buy and hold investor.  I will also assume that you plan to manage the property yourself, so no management fees are included here either.  If you plan to use property management simply add those costs on, but be aware they can vary greatly.

Let’s begin to put pencil to paper (or clicks on a keyboard) and work backwards from the rent to determine if a property is a good deal.  Let’s see if the asking price is anywhere close to what you can offer.

How Much Rent

The first number you need to write down is the estimated rent the property will generate.  Write it down as a yearly and monthly number.  This number will be gross rent.

Rental rates are determined by a lot of different factors.  Location, location, location are the first three.  After that, items such as size, condition, number of beds and baths and other amenities come into play.

You may know your market very well and be able to guesstimate rent quickly.  If not, start looking online.  Use general websites like zillow and rent-o-meter to get a general idea.  Then look for local property management websites.  You want to try and find nearby properties that are or have been recently for rent to compare prices.  Your goal is to find pictures of comparable properties so you can examine their condition.  Condition can sway rent ranges significantly.

How Much Cash Flow

The next step is to determine how much positive cashflow per month you want.  Even though this is the last number you will see in the process of determining if a property is a deal or not, you need to figure out what you want it to be ahead of time.

You can think of cashflow in terms of rate of return or cap rate.  But I just like to use a dollar figure, say $100 to $150 per unit per month.  I find such a number easy to use and work with.  It translates easily.  For example, if I want to replace $2,500 of monthly W-2 income, I can quickly determine how many units at $150 per month will I need to acquire to replace it.  It is easy to calculate and easy to see your goals.

How much cash flow you want and are able to get is going to depend on many things.  It will depend on your goals, it will depend on your market and it will depend on how you choose to finance your acquisitions.  For now, just remember that this number can be a bit fluid.

The Hard Numbers

The next step in your analysis is to write down the hard numbers.  These numbers are easily determined.  I prefer to break these numbers down into monthly amounts.  They are:

  • 10% of gross rents for maintenance.
  • 10% of gross rents for vacancies.
  • 10% of gross rents for reserves.
  • Monthly property taxes (be aware this number might increase after a sale).
  • Monthly property insurance.

The Not So Hard Numbers

There are a two numbers that still need to be factored into your analysis.  These are more adjustable depending on your personal preferences and how you run your business.

The first number is the cost of repairs.  Often we investors buy properties that are distressed and in need of repairs.  They may need new roof or HVAC equipment along with new paint and kitchen counters.  How much to do is up to you and what your market will bear.  Keep in mind of course that if you want to get top dollar in rent the property usually needs to be in tip top condition.

The second number is the cost of using other people’s money (OPM).  One of the great things about real estate is that we investors often use other OPM.  You can use your own money of course, but it often makes sense to use someone else’s.

Most times using OPM results in a principal and interest number and is based upon the rate of interest charged for a loan.  The loan amount can vary based on what you intend to offer to purchase the property and the amount of repairs you want to finance.  This number can vary based on the interest rate and the amount financed.   And don’t forget to include points, holding and closing costs.

Obviously this number can vary greatly depending on loan terms and the deal structure.  There are many ways to structure a deal and use OPM.  However you do it, just be sure to include these costs in your calculations.

The Sum Up

Once these numbers are arrived at, it is just a matter of some simple math.  The key is to arrive at your preferred cash flow by working backwards from the rent after subtracting all of the above.  If you find that you hit your cash flow target, look again and make sure your numbers are right.  Then make an offer.  Next time I’ll go through an example. I will also write in the future about how a deal that looks good on paper may not actually be so good.   Stay tuned.

Memphis, TN – A City of Renters

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There is a reason why the rental market is so strong here in Memphis, TN and why they keep adding more rental properties to the market.

We are a city of renters.

Here is a snippet from a recent article in the Memphis Business Journal.

“Memphis had the largest increase in renters among the 50 largest metros in the U.S., going from about 45 percent of residents who rented in 2006 to 56 percent in 2016.”

You can read the entire article here.