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Finding the Financing

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Exclusive for Smarter Landlording

Finding the Financing

By: Jimmy Moncrief

Since I know Smarter Landlording readers are focused on working “smarter, not harder” I wanted to write about a smarter way to get financing.

When acquiring a property the vast majority of real estate investors spend 99.9% of their time looking property.  They make a ton of offers, finally get a property under contract, then frantically scramble for financing.

Does that seem smart to you?

Of-course not.

Here is the smart way to pursue “smart financing”

Have a goal this week of making contact with at least 1 lending institution a day.

Here’s the schedule:

Monday: 2 credit unions

Tuesday: 2 small community banks

Wednesday: 2 regional banks

Thursday: 2 national banks

Friday: 2 hard money lenders

When you call ask for the person that makes commercial loans.  Commercial lenders are less restricted by consumer regulations.  They will be significantly more flexible. Before you start telling them about yourself. Simply ask them what kind of loans they are looking for.

At the end of the week, you should have a list of contacts for your next deal.

If you want to take it a step forward, go ahead and send them the information they request for a new loan so you are already pre-approved and you know what kind of loan you are qualified for.

Jimmy Moncrief is a bank underwriter and real estate investor.  He writes at: http://realestatefinancehq.com/

He has provided an exclusive report for Smarter Landlording readers: Top 6 Things You can do to Negotiate better terms from Banks: http://realestatefinancehq.com/smarterlandlording

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.

5 Forecasts For 2012

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So I am going out on a limb here with some forecasts for the New Year.  I say forecasts rather than predictions because it is impossible to predict the future, but I can speculate a little based upon current conditions and a little base knowledge.  Forecasting 2012 is much like forecasting the weather.  I know for example that here in Memphis in the spring cold and warm air masses will begin to interact with each other on a more frequent basis.  Sometimes this interaction will produce tornadoes.  I cannot say however where those tornadoes will touch down or how strong they will be.  There are just too many variables.

The same goes for 2012.  I know based upon what is happening now, such as Federal Reserve money printing or government market manipulations that certain things are very likely to happen.  I just can’t say exactly when or how significant the impact will be.  For that we will just have to wait and see.

OK here goes:

1.  Commodities such as oil, copper, gold, building materials, etc will continue to increase in price.  These increases are the result of money printing by the Federal Reserve and soon also to be by the European Central Bank and Bank of China.  Newly printed money always hits the capital sectors of the economy first before it makes its way down to consumer goods.  This is why commodities like copper have gotten so expensive that people will now take grave risks to steal it.  I do not see any sign of the money printing slowing so expect commodities to continue to increase in price.

Why should you care?  Higher oil prices are like a hidden tax, especially on lower income folks.  They will either have to buy gasoline to get to work or pay you rent, but will not be able to do both.  Higher prices also make new home construction much more expensive, slowing it down in all but the priciest parts of town.  Eventually the new money will make it to the consumer sector and food prices will begin to rise.  That’s when things will get fun.

2.  Interest rates will begin to creep up.  The United States borrows $20,000 every second!  Well guess what, with loose spending like that no one wants to buy our debt anymore.  In fact some like the Chinese have been selling it off.  So as demand drops we have to offer higher and higher interest rates to unload our debt.  Unless of course the Federal Reserve steps in to buy the debt no one else wants by printing money.  Then rates may stay low but see Number 1 above.

Why should you care?  Interest rates affect real estate prices.  Higher interest rates will put more downward pressure on prices.

3.  The Chinese economy is in trouble.  I expect to see some real turmoil in the Chinese economy in the coming year.  China has made remarkable strides in the past few decades, but it is still a communist, centrally planned economy in many ways.  Thus the number of malinvestments in China is staggering.  This malinvestment of capital and resources is going to have to be corrected and that correction is going to be painful.

Why should you care?  China makes all our stuff now, where will we get it all?  If China takes a dive, who will buy all that debt?  See number 2 above.

4.  Real estate prices will not recover much.  There are still a lot of malinvestments (bad loans, useless condos) on the books and in the foreclosure pipeline in this country.  We have not even begun to reach the bottom of the foreclosure crisis yet as there are thousands of people underwater and not even paying their notes.

Why should you care?  These foreclosures and low prices translate into numerous deals for us investors.  It looks like the deals will keep on coming.  I hope you can get some sooner rather than later though (see number 2 above).  And be sure not to bet on price appreciation, unless you are a farmer.  Bet on positive cash flow to stay strong.

5.  Lending to real estate investors will remain flat.  Banks made a lot of bad decisions (malinvestments) in the past decade and a lot of that junk is still on their books.  They are either so backed up with foreclosures, or do not want to take the write downs, or simply no one wants to buy their bad loans and inventory.  In fact, I bet we will see bank closures and forced fire sales to other banks in the coming months.  Bottom line, the bankers are scared of real estate, especially investment real estate and will be for some time.

Why should you care?  One of the best things about real estate is leverage or using other people’s money (OPM).  Traditionally banks were the place to go to get OPM.  Those days are over for now.  Does that mean you quit as an investor?  No!  This is the best time to be buying real estate (you read number 4 above right?)  You must adjust.  Find private lenders and offer then a nice interest rate (especially now while rates are low!  See number 2 above).  Or find a wholesaler who has private financing in place.  They are out there.

So there you have it (wow that was a longer post than I thought it would be).  My five forecasts for 2012.  It is not all doom and gloom.  In fact it is a great time to be a real estate investor.  But one must watch the trends, study the data, make the forecasts and adjust accordingly.

Till next time, work smarter not harder and Happy New Year!

 

 

Podcast – Why Invest in Real Estate

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Check out my latest podcast where I along with Jo Garner and Richard Scarbrough discuss why you should invest in real estate.  Originally aired on AM 600 WREC on 12/3/2011.

5 Financial Reasons to Invest in Real Estate

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Fourplex apartments can be a great cashflow generator.


You have probably heard that real estate is a good investment.  You may even know some people who are active investors.  You may even be thinking yourself that you should get into real estate investing (you should be).  But have you ever thought about why real estate is such a good investment.  My friends and fellow investors Richard Scarbrough, Jo Garner and I briefly went over the reasons why on the radio this past Saturday.  Since we were constrained by time, I thought I would share some more detail.  Be sure and read through for a bonus at the end of this post.

 

There are financial and non-financial reasons why real estate is a good investment. I’ll go through the top 5 financial reasons today and save the non-financial reasons for a future post.

  1. Cahsflow is KING in the real estate investing world.  Cashflow is income from the property such as rent, less expenses including principal and interest payments, insurance, property taxes, 10% repair credit and 10% vacancy credit.*  For example, if monthly rental income is $1,000 and your monthly expenses total $850, that leaves a monthly cash flow of $150 or profit per month. Cashflow is King!  Are you beginning to understand the beauty of real estate?  All of your expenses are paid by your tenants.
  2. Leverage – Leverage simply means having the ability to use other people’s money (OPM).  Think about how you purchase real estate.  You purchase it with a loan or mortgage.  That is using OPM.  You can even purchase real estate with no money out of your pocket, entirely using OPM!  Even better, your first purchases will often utilize a low, fixed interest rate payable over thirty years.  What other investments allow you to do this?  What if you wanted to buy some gold coins (you should be doing that as well, but that is another post)?  Would a bank lend you the money to buy gold?  How about stocks or bonds?  The answer in general is no.  You would have to come up with 100% of the purchase price to buy any of those other investments.  Leverage is a huge advantage for real estate investors.
  3. Monthly Mortgage Paydown – Owning real estate also allows you to build wealth every month.  Every time you make your mortgage payment, some of that payment goes to interest and some goes to principal.  The portion that goes to principal is just like putting money in the bank.  Every month you owe a little bit less on the property and have little more equity on your balance sheet.  Plus, remember who is paying it down for you, your tenants!
  4. Federal Tax Savings – We all know that Uncle Sam takes a chunk with income taxes while allowing fewer and fewer deductions.  Real estate investing is one of the few methods that can actually bring your earned income down to zero!  Yes, zero so you pay little or no federal income taxes.  Now, I’m not doing anything illegal and do not suggest you do either.  However I do take every legal deduction available and there are many.  One of the best is something called depreciation, but that’s another post for another day.  Want to learn more about the tax benefits of real estate investing?  I suggest reading this (Nolo’s Every Landlord’s Tax deduction Guide) book.  (Please note that I am not a CPA or professional tax advisor.  Please consult an appropriate expert before completing any investment decision.)
  5. Appreciation and Equity – You may not think that this applies today with the recent real estate boom and bust.  But part of the art of being a real estate investor is finding the good deals, deals where equity and appreciation are still available.  They are out there.   Find one and get instant equity when you close.  Plus, we are pulling out of this recession and while real estate still has to hit bottom in some areas, it will eventually start to appreciate slowly once again.

 

There you have them, the top five financial reasons why you should invest in real estate.  And here is the bonus I promised.  With any other investment vehicle, such as stock, bonds or precious metals, you might get one, maybe two of these financial benefits.  Owning real estate gives you all five.  There is no other investment vehicle that gives you all of these benefits.

 

I’ll blog again soon about the non-financial reasons to invest in real estate.  Until then, work smarter, not harder!

 

* As a general rule of thumb, always allow for a vacancy credit and a repair credit equal to 10% of the gross monthly income.  If a property’s income is $1,000 for example, then the vacancy and repair credits would be $100 each.