SMARTERLANDLORDING

ADVICE FROM EXPERIENCE

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Real Estate News This Week

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Here is a round up of real estate related news stories I found interesting this week.

  • Home sales in Memphis, TN were either up by 8% or 12% for the month of January depending on who you talked to.  Either way they were up!
  • The foreclosure crisis has decreased home ownership rates across the US.  Less homeowners means more renters.  The market is waking up to this fact.  Keep your eyes open for a possible multi-family price bubble in the future.
  • Banks may have finally figured out that short sales are a good way to dispose of some inventory.  Perhaps now investors will actually be able to complete short sales!
  • Commercial real estate is overbuilt.  The times are changing and businesses like Amazon.com are leading the way.
  • A quick take on the robo-signing deal.   A good deal?
  • Now that the robo-signing deal is done, people may not get to live for free anymore and will actually have to pay their mortgages or rents.  That may suck as much as $50 billion out of the retail economy.
  • Big money is looking to start buying up all those foreclosed single family homes and rent them out.

“The new loan program would likely be only available for deals of $100 million or more.”

 

 

 

Anything else catch your eye this week?  Send me a message and let me know.

 

Choosing An Investment Strategy

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There are essentially three ways to invest in residential real estate.  You can wholesale, retail or buy and hold.  Each has its pros and cons.   Let’s go through each one.

Wholesaling

Wholesaling is acquiring a property for a quick turnaround to another real estate investor.  This strategy is sometime referred to as “flipping.”

Pros

  • You are in and out of the deal quickly.
  • You do not need much capital to get started.  Since the object is to quickly turn the property to another investor, often very little cash is needed, especially if you can just assign your purchase contract to the other investor for a fee.
  • You can earn a quick $1,000, $5,000 or even $10,000 per deal.
  • You do not have to worry about rehabbing the property.  The Rehab is the next investor’s problem.  You may however need to do a little clean up to make the deal work.
  • You do not have to deal with tenants.  Tenants are also the next investor’s problem.

Cons

  • Requires a lot of marketing to both find and sell the properties.  Developing the tools to get sellers calling you and developing a reputable buyers list takes both time and money.
  • Those quick $1,000, $5,000 and $10,000 chunks of cash are considered active income by the IRS and are thus subject to Social Security and Medicare taxes and well as standard income taxes.  So put some aside from every deal you do.

Retailing

Retailing involves acquiring a property to fix up and sell to a retail buyer.  These are generally only single family homes.

Pros

  • The main pro is the big chunks of cash.  The average retailer can shoot for a profit of between $20,000 and $30,000 or more per deal.
  • The pride and satisfaction of fixing up and getting someone setup in a home.

Cons

  • You will need capital to purchase, fix-up and hold the property until you can sell it to a retail buyer.  Holding costs, such as utilities, insurance and property taxes need to be figured into the deal accordingly.
  • You will need contractors to help you rehab the property.
  • Dealing with retail buyers can be tricky.  They can be very finicky and you may have to wait a while for the right one to come along.
  • You will generally need to use a realtor and that adds commissions to the costs.
  • You need to know your retail market backwards and forwards as well as the neighborhoods you are investing in.  Talk to the neighbors and analyze comparable sales as much as possible.
  • Those big chunks of cash are taxed in the same manner as above in wholesaling.  Be sure to set aside some of the profits for Uncle Sam.

Buy and Hold

The buy and hold investor is a landlord.  He or she buys and holds properties to rent for the long term.

Pros

  • This strategy is a huge wealth building machine.  The other strategies provide chunks of cash but this one builds long term wealth.
  • It provides a monthly income from the rents.  You do not have to wait for a buyer to come along to get paid.
  • You are buying a real asset.  You can fix it up and improve the value.  Try that with Exxon stock.
  • Perhaps the best pro is the tax breaks.  Rental income is considered passive income by the IRS.  As such, there are no Social Security or Medicare taxes.  You also get the benefit of depreciation which can significantly reduce active income and thus the tax you pay.  To learn more, pick up this smarter resource.

Cons

  • One word, tenants.  Proper screening can however eliminate many headaches.
  • There are repairs.  Always set aside at least 10% of your gross monthly rental income for future repairs.  Trust me, you will need it.
  • Management is also an issue.  You have to manage your properties in order for them to produce for you.  You need to check on them once in a while and make sure all is ok.  And if you think you can eliminate management with a management company think again.  Now you need to manage the management company.

Which strategy is right for you?  That depends on your personality and what your goals are.  I have done all three but I am generally a buy and hold guy.  I like the monthly income, I can focus on one specific area and I dislike waiting for a retail buyer.

If you are just starting out and need to acquire some cash per haps wholesaling is the right choice for you.  Have cash to invest?  Maybe a couple of houses to hold and rent is the right choice.  Many investors do a little bit with all three.  They like the large chunks of cash, the monthly income and tax breaks from landlording.

Whatever you do, decide to do one of these three strategies today.  You will not regret it.  And if you need to learn more about real estate investing, check out your local REIA group.

 

 

 

 

 

Future Real Estate Investors

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Ridgeway HS Investment Club

Many thanks to the newly formed Ridgeway High School Investment Club.  They invited me to speak to them this afternoon about real estate investing.  You have got to admire these kids for sitting and listening to me after school when it was a beautiful 70 degrees outside on February 2!   I enjoyed talking with you and I wish you much success in the future!

The “Right” Business Structure

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Real estate comes in all shapes and sizes and there are numerous ways to invest in it.  Smarter investors look very closely at how their real estate business is structured because the wrong structure can cost them a lot of time, effort and money, while the proper structure can save and protect their hard earned assets.

There are three basic types of business structures, the sole proprietorship, the partnership and the corporation (including limited liability corporations or LLCs).  Each of these structures, like everything else in this world, has pros and cons attached to it.  Let’s look at each one.

Sole Proprietorship

The sole proprietorship is just what it sounds like, you, the individual investor conducting your real estate business.  Usually individuals set up a business name, such as ABC Properties, and then set up their accounts to read as Joe Investor, doing business as (DBA) ABC Properties.

Pros

  • It is easy.  Pick a name and you are in business.
  • It is simple.  Set up a separate DBA bank account and off you go.  Plus the income tax returns are just included with your personal  1040 form.
  • It is easy to end.  Just stop it.

Cons

  • There is no liability shield.  Everything good and bad passes through to you.
  • You are visible as the owner.  There is no anonymity.

 

Partnerships

Partnerships are created when two or more people get together for some sort of business venture.  In real estate investing, partnerships are usually formed because one or more partners have some sort of specialized experience needed for the particular deal.  Or, one or more partners may be bringing their money to the table to fund the deal.

Pros

  • They are easy to set up and start.  No public documentation is generally required.
  • They can be easy to dissolve and can even be specific to a particular deal.
  • Partnerships can bring together people that will make an otherwise unworkable deal workable.  One partner may have money, rehab experience or a list of potential buyers for example.

Cons

  • No liability shield protection.
  • Enhanced level of bookkeeping and federal income tax knowledge needed.  The IRS Partnership Form 1065 is needed for example.
  • Partnerships can get messy.  A partnership operating agreement is a must and it should be reviewed by a qualified attorney.

 

Corporations and LLCs

Corporations and LLCs are legal entities.  They are separate and distinct from you the individual.

Pros

  • Liability shield is in place between you and your investments.
  • They are fairly easy to set up.
  • They can provide you with a more professional image.
  • They can help maintain anonymity.
  • Depending on your business, they can provide various federal tax benefits.
  • Can be a good way to raise funds.

Cons

  • Require paperwork to be filed with the state along with initial and annual filing fees.
  • The laws and rules governing corporations can be complicated.
  • There are annual paperwork, meeting and filing requirements that must be completed.
  • You will often need to pay for professional legal and accounting advice (In Tennessee for example, a corporation or LLC must hire an attorney to represent it in court for example)
  • There are increased bookkeeping and tax reporting requirements.  You must keep all monies separate if you wish to keep that liability shield in place.
  • Banks will not lend to newly formed corporations.  In general, a corporation must be in place for at least three years before a bank will consider lending to the corporation.  So you will not be able to put your investments in the corporate name anyway.

Which one is right for you?  That depends on what you are doing and what your comfort level is.  For those just starting out in real estate investing, I would keep things simple with a sole proprietorship or a partnership.  Don’t over complicate your life when you are just starting out.   If you are worried about getting sued because you do not have a liability shield (and you should be!), just be sure to get a liability insurance policy of at least $1 million to $2 million.

As your real estate business grows and expands, you may want to consider an LLC or corporation, you may even want to consider having several of them.  Why?  Because it is more advantageous tax wise to put long term holds into an LLC and it is more advantageous to use an “S” corporation if you do a lot of retail and wholesale flips.  So if you do both in your business, you may want both types of structures.  Plus as you continue to read this site and become larger and more prosperous, you will become a bigger target and may want the protection a corporate shield offers.  If you own a lot of properties, you may want several different LLCs to “split up” the properties into different entities for asset protection purposes.

Again, it is all up to you and what you want to do and what your comfort level is.  I know investors with layers of corporations and I know investors who have done hundreds of deals and own dozens of properties as sole proprietors.  It just depends on the individual.  In the end, there is no “right” structure.

Whatever you do, don’t just take my word for it.  Do your own research.   Check with and talk to a qualified attorney and accountant in your local area about these issues.  There are local rules and regulations that may make your situation unique.

Until next time, invest smarter!

Rents Are Up, Housing Still Down

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Rents are starting to go up.  According to the Federal Reserve Bank of Cleveland:

Rents are starting to accelerate. Rent of primary residence rose 3.1 percent in December, and has risen 3.5 percent over the past six months. Owners’ equivalent rent (OER) rose 2.2 percent in December and is up 2.3 percent over the past six months. Interestingly, all but one of the regional OER components we use to compute the median CPI posted an increase near 3.0 percent in December (the median component was OER: Midwest, which rose 2.9 percent).

Rents are simply responding to the laws of supply and demand.  Demand for rental properties is up as the number of renters has increased significantly due to the foreclosure crisis and a reduction in the amount of available credit for home loans.  The market is responding to this increased demand for rental units.  According to the US Census Bureau, the number of permits for the construction of multi-family units are up over 50% since December of 2010.

Single family home construction continues to be in the dumps.  New single family home construction permits are down over 75% from the boom time highs, as this chart shows:

What does all this mean for the average investor?  First, if you own rental property, keep it.  Rental inflation and thus rental profits should increase over the coming year.  Second, continue to buy and hold rental properties if you can.  Third, if you’re a flipper, buy and hold investors are going to be your buyers.  Fourth, continue to be very careful with retail flips.  Very few areas are viable retail markets right now so choose wisely.

It is more and more obvious to me that real estate investors are going to be the ones that get us out of this mess.  I just hope the banks and our government begin to realize it as well.

Podcast – Your Real Estate Journey

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My latest podcast where I along with Jo Garner and Richard Scarbrough talk about beginning your real estate investing journey and some of the things you should consider if you want to get into real estate investing.  Originally aired on AM 600 WREC on 1/7/2012.

 

 

Why I Dread January

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I dread January.  Not just because it is cold but also because I have to start thinking about income taxes and our state legislature comes back into session.  Every year you can be guaranteed that someone in the legislature will propose a bill that will make it harder for me to be a landlord.  A bill I will have to oppose.  This year is no different.

 

This year it is HB 2227.  If you are an investor in Tennessee, you should be concerned about this bill.  This bill will create a registry of all rental properties and their owners, charge me for the privilege of registering and then threaten me with fines and eventual jail time if I fail to register.  It would also require me to create a registry of all of my tenants by keeping a copy of an “appropriate ID.”

 

A registry is unnecessary as the county property assessors have that data anyway and why do they care who I rent my properties to?  I suspect there is more to this bill that will come out in the coming years.  This bill will do nothing but create a further burden on an already burdened industry.  It is all about gaining more control over the real estate investing industry.

 

I guess they think I don’t have enough to do in my business.  I now have to shift time and resources towards fighting this bill.  Time and resources that could be used much more productively growing my business.

 

I do not know who said it but I tend to agree more and more with this quote every year, “Our legislature meets once a year for 99 days.  But I wish they met for only one day every 99 years.”

 

I’ll have more to come on this issue as it develops.

What Properties Should I Invest In?

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I have often been asked by people wanting to get into real estate investing for advice about the types of properties they should invest in.  There are so many different kinds of real estate investment types, from single family homes, to farms to industrial parks and there is nothing wholly right or wrong with investing in these various types of real estate.  Each has advantages and disadvantages.   But in my experience, residential real estate is the easiest to get into and the learning curve is the shortest.  So for the new investor, I recommend residential real estate investment properties and that is what I am going to discuss in this post.

 

There are three types of residential investment properties.  All three can be great investments.   Just be aware of the advantages and disadvantages of each type before investing.  Let’s go through each one.

 

Single Family Homes – Single family homes are properties with just one dwelling unit in them.  They can be detached homes on acre lots, town homes, even condos fall into this category.  Single family homes can be great investments.  One of the best features of single family homes is that they generally are the only properties you can sell on the retail market.  You often therefore can get a higher sales price when you sell than you would with other type of residential properties.

 

In today’s market there are many, many homes out there that are priced right and will generate positive cash flow.  In fact, right now they are the cheapest I think they are going to be for a long time.  Even thought prices have declined, rents have not.  Properties in desirable neighborhoods can bring good rents and very stable tenants.

 

New investors can also get some very favorable financing for single family investment properties right now.  Rates are currently amazingly low.  Investors with W-2 (regular job) income and a good credit score can get up to 10 investor loans with low fixed rates financed over 30 years, just like you can with an owner occupied house.  So both pricing and loan rates make this type of investment property very attractive.  (Here is a tip.  If you are married be sure to put these loans in only one spouse’s name.  That way you can get 20 loans, 10 in each spouse’s name.)

 

In many areas however, the prices of single family homes are far higher than the rental income they will produce can cover. In other words, unless you are paying in cash for an expensive home or have a large down payment, the amount you will have to finance will not create positive cash flow.  Be careful buying in pricier neighborhoods.

 

A downside to single family homes is the fact that when your tenant moves out, your house is vacant and producing no income.  You need to move quickly to get your property re-rented.  Vacancy is a cash flow killer!  For example, if your monthly cash flow is $150 per month on a home that rents for $900 per month and it remains vacant for a full month, you have just lost 6 months of cash flow profit.  Plus, when they are empty, they are more prone to theft and vandalism.

 

Duplexes, Triplexes and Four-plexes – These are the two, three and four unit properties or smaller multi-unit properties.  These also make great first time real estate investments.  The main advantage here with these multi-unit properties is that they will still produce income when one unit becomes vacant.

 

Another advantage for the newer investor, you can often get the same types of loans mentioned above with single family homes.  This is because Freddie Mac and Fannie Mae, the buyers of these loans, treat these multi-unit properties the same way they treat single family homes.

 

These smaller multi-unit buildings can still possibly be sold to owner occupants.  So the market for these properties is a little stronger than it is for others.  They can often be sold to someone like me perhaps.   When I was beginning my investing career, I wanted to generate some extra income so I bought a duplex and lived in one side while I rented out the other.

 

Apartment Buildings – Apartment buildings are properties that contain five units or more.  These types of properties can really be income producers.  However, they can also be real drains if they are mismanaged.

 

Management of these types of properties has to be strong or they can quickly get out of hand.  Tenant issues and faulty maintenance can quickly add up to a negative cash flow situation.  You might think you can hand this type of property over to a property management company.  But if you do not know how to manage your property or manage the property management company, you will end up on the short end of the stick every time.

 

Financing these properties is also much harder.  Say goodbye to 30 year loans that you can get with the above properties.  To purchase these types of investments, you will most likely need to go to a local bank and get an officer’s line of credit or commercial loan.  These loans have significantly higher rates and much shorter terms.  Often terms of 5 years or less.  In this way they are very much like commercial or industrial properties.

 

Selling these properties is also much harder than with other types of residential investment properties.  Think about it.  Who is going to buy these types of properties?  Certainly not a retail buyer, but another investor who is going to be looking at the same cash flow numbers you were when you bought the property.  In other words that investor will be looking for a deal just like you were.

 

What should you buy if you are just starting out?

 

I would suggest starting with a duplex, triplex or four-plex.  You can generally get decent, long term financing.  They will produce income with multiple units as opposed to sitting vacant.  The resale market is fairly good for these types of properties.  These three factors help reduce the risk for you first time investors.  If these types of properties are not available where you live, then go for single-family homes in stable neighborhoods for many of the same reasons.  Whatever you decide to do, do get into real estate investing today.  Make it a goal to buy one or two investment properties this year.  The combination of low prices and low rate may not be seen again for a long, long time.

Will 2012 = Less Vacancies & Higher Rents?

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The vacancy rate for apartments in the US fell to a 10 year low at the end of 2011.  According to Reis, Inc., the vacancy rate fell to 5.2%.  That rate is down from 6.6% a year ago.

 

And as the supply of available apartments decline, guess what goes up?  You got it, rents!  The average monthly rent for the US as a whole increased 2.3% over the past year to just over $1,000.

 

If you are planning on going to Yale University in New Haven, CT, start shopping early for a place to live as they had the nation’s lowest vacancy rate.  New York City, Minneapolis, Portland Oregon and San Jose California rounded out the top five.

 

California took the top two spots for effective rental rate increases.  San Francisco and San Jose were number one and number two with Chattanooga, TN, Austin, TX and New York filling in the top five slots.

 

Jobs are the key to these rent increases.  Both San Francisco and San Jose are seeing new jobs in the tech sector, while Randy Shelly with the Chattanooga REIA explained to me that “he is not surprised” as the Chattanooga area has had a new Volkswagen plant come on line and an Amazon.com distribution center make plans to expand.

 

It seems like 2012 may be shaping up to be a good year for landlords.  I can say that here in Memphis any apartment I have that becomes available has been re-rented fairly quickly in what are supposed to be the slow months of November and December.  But, I have not generally been able to push rental rates up yet.  What have any of you readers experienced?

 

UPDATE

Here is a link to an article in the Daily News which somewhat echos what I said above.  Rents have been pretty much stagnant in the Memphis area as have vacancy rates according to the article.  Perhaps the decrease in vacancy rates I have experienced is due to my particular sub-market.

The Many Hats of the Real Estate Investor

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The real estate entrepreneur (or any entrepreneur for that matter) wears many hats throughout their investing career.  This is especially true when they are just starting out.  As your business grows, you can hopefully begin to hire others to take some of those hats off your head, but some you will always wear.

 

Here is my list of the many hats I have worn and still wear to some extent today.  Some were expected.  Some fit quite well while others were difficult to put on to say the least.  As I write this blog in the coming weeks and months I want to be able to share with you how I wore these various hats, what I learned and what I would do differently if I had it to do over again.  In other words, learn from my mistakes so you can be smarter than I was.  Till then, here is my list.

 

  • CEO – You knew about this one.  Of course you are in charge, this is your business and the buck stops with you.  But it is not like sitting in an oak paneled office smoking cigars and collecting stock options.  You are the decision maker and your business will sink or swim due to the decisions you make, so choose wisely.  This is a hat you will always wear.

 

  • CFO – Are you good with spreadsheets?  Can you balance your checkbook?  Understand all those IRS rules?  I hope so, because as Chief Financial Officer you control one of your company’s most important assets, cash!  Some words of advice for you.  Watch every penny and put money aside every month for a rainy day because sometimes it storms and never take this hat completely off.

 

  • Acquisition Manager – You had better know those three words that drive all real estate, location, location, location.  Pick a good location (a neighborhood, a city or even a region), learn the numbers of that location and start farming it for properties to add to your portfolio.  You can teach others to do this, but keep this hat close.

 

  • Asset Manager – You have to keep your properties maintained or good tenants will go elsewhere.  That means they need to look nice and you need to fix problems quickly.  Tenant turnover is a killer in this business.  If you find a good tenant, work hard to keep them by giving them a nice, safe and secure place to live.  To do that you will need to wear a few of sub-hats here.

 

    • Contractor – Most likely when you are just starting out in the real estate business you are going to save many by fixing up the property yourself.  You will do some drywall, painting, refinishing floors, etc.  This is good because you do save some money and you learn how to do these things when you eventually do hire a contractor.  Pick up this book to help you.

 

    • Handyman – Do you know how to fix a washing machine?  How about replace an element on a stove? Patching a roof perhaps?  Better learn.  This book was really helpful to me.

 

    • Landscaper– Grass needs to be cut and leaves need to be raked.  Bushes and trees will need to be trimmed and trash picked up.  When you are just starting out this is one of the

 

  • Sales/Marketing Manager – You will need to sell your rentals to potential tenants.  Why should they buy from you?  Why is your property any better than the one down the street?  Putting a “for rent” sign in the front yard and hoping for the best is not enough anymore.  You need to be found and you need to show prospective tenants that you are a professional, and that they will be respected and treated well.

 

    • Webpage Designer – If you are not on the internet these days, the world is almost blind to you.  Professional designers can charge thousands of dollars.  This expense is unnecessary, especially when you are just starting out.  There are many services and programs out there that will get you up and running on the web for minimal costs.  Just look at the site you are reading.

 

  • The Legal Department – You will need to know your local laws regarding rental properties and evictions, otherwise you will make some stupid mistakes.  In addition to that there are zoning issues, building codes, housing codes and tax codes.  Better be at least aware of these things and know when and who to call when you need a competent attorney.  You can find one here.

 

  • Secretary – Need something mailed?  Need some stamps and office supplies?  Need copies made?  How about setting up those tenant files?  Heck, you even get to make the coffee!

 

  • Receptionist – You are the first contact people will have for your business and the old saying is true, you only get once chance to make a good first impression.

 

  • Housing Code Enforcement Officer – “You mean I can’t park on the front lawn?”  No.  “But I need that scrap metal for my sculpting class.”  OK, but you can’t keep it on the front porch.  “You just do not understand art.”  Be that as it may, the 10 foot tall inflatable Santa still in the tree in February needs to go.  How do you find out about these things?  Hopefully it is not because of a letter from the city, but because you are proactive and regularly drive by and inspect your properties.

 

  • Life Counselor – Our house rules state that we do not do tenant drama (it really does!), but sometimes you still get sucked in.  Roommates get in fights and want to move before the lease is up.  Couples split up.  People loose their jobs.  Life happens and you get caught up in it.  Be cool, calm and professional.

 

  • Mover – Need to get somebody out?  I have helped them load up the car to hurry things along.  Did I want to do it?  No.  Did I want them out of my property?  Yes.  Sometimes you just got to do what you got to do.

 

So there you have it, my list of 15 hats.  Did I miss any?  Let me know.  Until next time work smarter not harder.