SMARTERLANDLORDING

ADVICE FROM EXPERIENCE

Landlording

Spring Break

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Spring has sprung here in Memphis, TN.  It came a little early this year after a very mild winter.  I’m sure a lot of people now have spring fever and want to get outdoors or to the beach for spring break.  For me however spring break has another meaning, spring means repairs, a lot of them.

It seems that whenever the seasons change, things start to break.  In the spring with the March winds and April showers it is missing shingles and roof leaks.  With the rising temps, people start up their air conditioners and some will need recharging while others may not work at all.  All of the landscaping and trees turn green again and need cutting, pruning and trimming.  In short, it seems every seasonal change, with spring being one of the most drastic, brings a clump of repairs.

It is uncanny.   As soon as the temperature changes, the phone calls start coming in.  “My AC is out.”  “There is a leak in the kitchen ceiling.”   So far this spring I have replaced a condenser, a fan motor, recharged several AC units, fixed three roofs with two more to go and removed two trees that blew over.  And it is not even April yet!  So what does a smarter landlord do about all of this?

  • First, just know it is coming and accept it.  Things break and spring is a deluge.  In the winter it is the heat and frozen pipes.  This is just the way it is.
  • Second, save up some funds.  In a previous post I have stressed the importance of budgeting 10% of gross rents for repairs and putting away a little bit more each month for major expenses in reserves.  Trust me, spring break it going to make you (and your tenants) glad you did.  Understand that you will not have 10% worth of repairs every month.  Some months may have no repairs, but averaged out over the year 10% is a good number.  My repairs for all of 2011 totaled 10.14% of gross income.  Almost right on the money.
  • Third, have some skilled contractors on your team that you can call to fix the problem quickly.  You will need a roofer, a plumber, a good HVAC person and a landscaper/tree person.  By having these people on your team you can handle repair problems quickly and thus cut down on an even bigger expense, tenant turnover because you did not fix stuff in a timely manner.  Where do you find these team members?  Your local reia is a great place to start.
  • Fourth, take the opportunity to be proactive and do a little “spring cleaning.”  Now is a perfect time to inspect your properties, both inside and out, for damages and other problems.  Contact your tenants and let them know that you will be conducting an inspection.  Then, check their HVAC units and change the filters (tenants never do it), check their smoke detector batteries, check the plumbing for leaks and check around the outside for other general repairs such as fallen limbs, rotten wood, etc.

A smarter landlord has to be proactive and routinely check on their properties.  I would recommend that you conduct an inspection at least twice a year.  Perhaps once in the spring to check their AC, clean the condensers, etc., and once in the fall to check their heat.  Always look at the plumbing under sinks, around toilets, etc.  I can’t tell you how many leaks I have found that had obviously been going on for months and the tenant says “Oh yeah, I was going to call you about that.”

So there you have it: spring break, accept it, prepare for it and be proactive.

Until next time work smarter not harder.

Is That a Good Buy and Hold Deal?

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Buy and hold deals are my favorite kind of real estate deals.  They provide you with monthly income and generate long-term wealth.

 

With buy and hold deals, cash flow is the name of the game.  The deal must generate positive cash flow.  A property is not a deal if it just breaks even.  It is not a deal if you have to write a check to cover expenses every month.  You want to collect checks, not write them!   Do not bet on price appreciation.  Appreciation is a nice benefit to get, but it is almost completely out of your control.

 

So how do you determine if a property will generate positive cash flow?  First, you need to determine how much potential income a property will generate.  Most of the time income equals rent, but there could be other sources of income such as utility and vending income.  For now, let’s keep it simple with rental income.

 

Expenses are more varied.  Let me list those:

 

  • Most of us need to borrow money to acquire the deal (if you do not, good for you!).  So your first expense is your principal and interest payment or the cost to borrow other people’s money.  This is the one major expense that we as investors have control over on the front end.  This control comes in the form of the price we can offer for the property.  Too high a price will skew the principal and interest costs up turning a potential deal into no deal.  Remember you make money in real estate when you buy.  So buy them right on the front end.
  • The second expense is property taxes.  Be sure you include everyone who can add a little piece to your bill.  Where I am today I just pay city and county taxes.  I recall living in Fort Lauderdale, Florida where there were no less than six or seven different taxing authorities.
  • Property insurance is third on the list.  The cost of this expense will vary depending on your location.  These first three make up the major expenses and are sometimes collectively referred to as PITI (Principal, Interest, Taxes and Insurance).
  • Repairs and maintenance are next.  Something always needs to be fixed and there is routine maintenance such as keeping the yard cut, raking leaves, cleaning gutters, painting, etc.  Budget approximately 10% of your gross rents in this category.  In other words, if monthly rental income is $1,000, budget about $100 per month for repairs and maintenance.   It will not always be exactly $100 per month.  Some months will be higher and some will be lower but over the course of time 10% is surprisingly accurate.
  • Vacancy is another expense you will have.  Your rental unit will never be 100% occupied 100% of the time.  If it is not occupied, it is not generating any income and you still have to pay the bills.  So a good rule of thumb is again to budget about 10% of your gross rental income towards a vacancy credit.  Depending on your location and market, this number can be higher or lower.  Use your own experience and expertise and adjust accordingly.
  • Utilities should also be figured into the deal.  There may be house electric meters or it may be common for the landlord to pay for water in your market.  Market conditions will vary, as will rates.  Some properties for example will be charged residential (lower) rates while others will be charged commercial (higher) rates.  Make sure you know your market and your rates.
  • Reserves are an expense that more and more bankers are asking about these days.  Reserves are funds that you set aside for those big future expenses such as roof replacements.  A lot of banks got burned in the real estate bust because landlords did not budget for this (among other things) and left the bank holding a ruined property.  If you are going to borrow bank funds, show them that you are going to set aside 10% of gross rents for future major repairs.  Plus it is nice to have that money there when something major happens (notice I said when not if).
  • Other expenses could include trash removal, homeowner association fees, advertising, professional fees (for lawyers and accountants), license fees and other various taxes.  These types of expenses will all vary depending on your local laws and market conditions.  Sometimes I just throw in a miscellaneous category of about 2.5% gross rents just to be safe.

 

Once you have determined your potential income and expenses for a particular deal, you can then list them to determine the potential cash flow.  Let’s say I am looking at a single family house that will rent for $1,000 per month.  The owner is asking for $50,000.  Is that a deal?

 

I always look for at least $150 per month positive cash flow after all expenses outlined above are paid.  I will also have to pay 7% interest with a 20 year amortization to borrow $50,000.  Those terms make my principal and interest payment $387.65 per month.

 

Let’s outline it.

 

Income (monthly)                                                $1,000

 

Expenses (monthly)

Principal and Interest                                        $387.65

Taxes                                                                    $50

Insurance                                                            $30

Repairs/Maintenance                                        $100

Vacancy Credit                                                    $100

Utilities                                                                 $0

Reserves                                                             $100

Misc.                                                                     $25

 

Total Expenses (monthly)                                 $792.65

So is this property a deal?  You bet it is.  Using the numbers above this property should generate a positive cash flow of just over $200 per month.  Not to bad.  If you buy 10 of these type properties they would generate $24,000 per year in positive cash flow.  What could you do with that extra money?  This positive cash flow is why buy and hold deals are my favorite deals.

Landlords Are Sitting Pretty and Other News Items

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If you have an extra billion or so lying around, you can pick up some really good deals from Uncle Sam.

Even if you do not have that much to invest you may want to get in the game since home prices have not been this low since 2002/2003.

Landlords are beginning to figure it out and may of them are sitting pretty!

Renting is Better 100% of the Time & Other News Stories

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As a landlord I have to like it when Yahoo reports that renting is better than owning 100% of the time!

 

 

 

 

It is also fun to watch the spin for a housing market recovery.

Home Sales Jump!  The housing market is recovering!

Well, maybe we spoke too soon.

The housing market is really comatose.   No, it’s more zombie like.

 

Meanwhile there are plans to downsize Freddie and Fannie.  And there are plans for more bailouts, this time by the USDA.

 

The bottom line is properties are cheap, money is cheap and renting is good.  Now is the time to buy.

 

 

 

Pick A Place To Farm

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No, I’m not talking about for growing corn, but for growing your real estate investments.  If you want to be a successful and smarter real estate investor, you should find a particular area and farm it for real estate deals.  It just makes good real estate investing sense.  Just as you would not try to scatter your corn crop all over the country or your particular city, you should not scatter your real estate investments all over the country or even all over your particular city (at least not at first when you are starting out).

Farming means selecting an area and then getting to know that area like the back of your hand.  You need know all the streets, the house types, average retail sales price, price trends, rental rates and rental trends.  By having all of this information on hand for quick reference, you can act quickly if a deal presents itself.  (In hot markets, quickly may mean as little as a couple of hours!)

Farming a particular city or neighborhood provides the real estate investor with many advantages.

  • You can easily get to know the area and quickly develop a “mental map” in your head.
  • It is much easier to keep up with comparable sales and rents on a farm as opposed to an entire city, region or country.
  •  A farm allows you to focus by limiting the amount of info (noise) coming at you.  This focus can really help you when you are just starting out.
  •  A farm will provide confidence as you get to know your farm more and more.
  •  A farm will save you time, money and hassle.  This fact alone is worth it!

Where should you farm?  I recommend you look for an area that is maintaining property values and where people have and hold jobs.  It does not have to be the nicest neighborhood or even the lowliest.  Although both of these types and everything in between will have deals in them for you to farm and grow.

I also suggest, at least when you are beginning your real estate investing journey, that you pick an area close to your home or work.  This strategy will provide you will several more advantages.

  • Your farm will be located in an area you are already going to, so no extra drive time.
  •  You will most likely already be familiar with the area.
  •  You can keep things close.  I really like this one since I manage my own properties.  This one really saves you time when there is an emergency in the middle of the night during an ice storm (ask me how I know this).

How big should your farm be?  The answer will depend on many factors, but here are a few guidelines.

  • It needs to be big enough so that you can find enough deals to invest in.  Farming only in your 30 lot subdivision will not give you much to eat.
  • It should not be so large that you are driving 30 minutes or more to get from property to property.  All of mine for example are about 10 minutes driving distance from my home.
  • The size will depend on your strategy.  If you are landlording it can be smaller, if you are wholesaling it will most likely need to be larger in size to find both sellers and buyers.
  • Size will also depend on where you are located.  If you live in a big city you may be able to focus on one or two neighborhoods.  If you live in a small town you may need to focus on the entire town.  If you live in a rural area you may need to think larger and focus on the entire county.

Farming is a great real estate investing strategy, especially for the beginning investor.  So get your maps out, grab a highlighter and pick your place to farm for your real estate deals.

Podcast – Choosing Your Real Estate Investment Strategy

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Real estate investing is a great way to build wealth, but which strategy is right for you? Should you wholesale, retail or buy and hold? All three offer great opportunities. Listen as Richard Scarbrough, Jo Garner and myself talk about the pros and cons of each strategy.  Originally aired on AM 600 WREC on 2/4/2011.

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.

 

 

 

 

 

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.

Fewer New Households Being Created

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Since the Great Recession began in 2007, the United States has witnessed a drop in the number of new households being created.  Moody’s Analytics estimates that there are about one million less households in the United States than there should be based on current demographics

New households are not being created more slowly in the US.

What’s a household you ask?  A household is simply persons who occupy a housing unit, such as a single family dwelling, an apartment or mobile home.  Households are normally created when children grow up and leave the nest.  Children go out on their own and get their own place.  But in today’s economy people are strapped for cash, so they are doubling up with friends and family.  People are living with roommates, other families or even going back home to live with mom and dad because cash is so tight.

So what?  Well as  landlords and real estate investors, household creation affects us greatly.  If people are doubling up with other people and not going out on their own, that translates into less renters or buyers for our properties.

I know many have said that rents should be increasing because fewer people can afford to buy a home these days and should thus be becoming renters.  However, while the pool of applicants has been steady in my market, I have generally not been able to increase rents due to increased demand (and I

have tried!).  I suspect this drop in household creation over the past few years has something to do with that.

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