Buying investment real estate
This is for anyone wishing to purchase investment real estate, all of whom I hope end up
with at least one or two pieces of rental property…It’s a relatively EZ way to build
wealth and make extra income.
Why you should invest:
-it’s the ONLY investment someone else buys for you
(the renter pays it off, not you)
-you can get it with very little down payment (0-25%)
(try buying stocks or bonds for that)
-it’s leveraged ($1 spent can equal several $ of profit)
-it has favorable tax consequences
(if you know what you’re doing, you’ll NEVER pay taxes when you sell)
-it appreciates (if you buy at the right time)
-profits go up every year (rent increases over time but the payment stays the same)
-everything related to it is tax deductible
(Uncle Sam helps you pay the expenses)
-it throws off income you can’t outlive (if you buy right and manage it right)
-it’s like having your own small business but the “employees” pay YOU, never call in
sick and require virtually no supervision
Before you start:
Read the books “Becoming your own banker: the Infinite Banking Concept” by
R N Nash or “Bank on Yourself” by Pam Yellen OR go to Findoutmorenow.com and
follow the instructions. If you do what they tell you, you will retire very comfortably
and never pay a dime in interest to anyone.
Go to the library and check out some books on the topic of real estate or go on the
internet and read some articles or blogs on this subject. You’ll learn a lot. Most big cities
have a “tenant’s council” website which is VERY informative. Read it ! Check out any
“real estate investor” clubs in your town.
Foreword:
Owning rental property is not for everyone. It “sounds” good but the reality can be
quite different. The majority of investors LOSE money in real estate primarily because
they have someone else manage it, they pay others for repairs (or pay too much), they
pay too much to begin with or they keep buying and selling. You must be good with
people. If you’re easily frustrated, impatient or get ticked off with people this is NOT
for you, go do something else. Don’t say I didn’t warn you.
If you can handle some hassles from time to time and don’t mind getting your hands
dirty, this MAY be for you. Start off slowly and see what you think.
This advice is what I think, get other opinions. YOU may decide something else is
better for YOU…
General Advice:
Get an experienced realtor who has worked with a lot of investors help you buy your 1st
property. Never buy in a “hot” market (where prices are rising quickly and there are lots
of buyers looking at few properties). Bide your time and save your money, the prices
WILL come down. A “bad” market is the time to buy, when there’s lots of doom and
gloom going around and everyone is talking down about realty. Baron de Rothchild said
“buy when there’s blood in the streets” and he was right ! Always ask the seller to pay
your closing costs AND make some repairs.
After you’ve been thru one transaction, you’ll see how EZ it is. Most people should
stick with single family homes (sfd, single family detached) because FAMILIES tend to
rent them and they tend to stay awhile. Tenant turnover is what kills your bottom line.
The longer a tenant stays, the better off you are. Don’t rent to unmarried people or
“room mates”, it’s inherently an unstable situation (if one of them moves out, the
other one usually can‘t pay the rent by themselves), you want LONG term tenants.
Married people tend to be more stable. Multifamily properties attract younger people
and those “on the move”, not good. MF may throw off more cash than sfd but involves a
lot more hassle & expense due to tenant turnover. MF structures are always in poorer
condition that sfd (probably because the vast majority are not owner occupied) and get
more abuse when they’re occupied.
Screen them using National Tenant Network, www.mysmartmove.com or someone like
them. I screen most everyone unless I just have a good “feeling” about them. This
comes with time and maturity and is a learned skill. Don’t do that right away.
Get as much deposit as the market will bear and the 1st month’s rent via a money order
or cash, never a check. After they move in, I will accept checks until one comes back
“nsf“, after that it’s MO’s only.
I like 4 bdrm homes in nice neighborhoods as they don’t cost much more than 3 bdrm
homes (if at all) but rent a lot faster and for more (appreciate faster too than property in
a less desirable area). 1200-1800 square feet is plenty big enough. Larger homes cost
more to carpet and paint and the tenant population is smaller. Most rent houses are 3
BR so if you have a 4 BR, you’re “one up” on the competition. Also, when you buy
houses and not multifamily, your property is surrounded by sfd which means a BETTER
neighborhood. Multifamily structures are surrounded by other MF buildings and the
neighborhood often looks bad (litter, tall grass, broken down vehicles, trash cans left
out etc.) Also, when you sell, only another investor will buy a multifamily structure
whereas an investor OR a homeowner will buy your HOME.
Some people say “if the HOUSE is vacant, I’m getting NO rent but if one side of my
DUPLEX is vacant, at least I’m getting SOME rent”. This is true and is the ONLY
benefit of MF as far as I’m concerned. My response is: “If you do what I tell you to do
in this article, your home won’t be vacant very long!”
Never buy a 4-plex unless it’s in a good area or it’s the only one on the street. The
worst tenants migrate to these properties for various reasons I won’t get into here. Lots
of 4plexes on a street means GHETTO, avoid them like the plague no matter how cheap
they are. They typically have high turnover and are often owned by out of town
investors who could care less about them. SFD in good areas appreciates faster than MF
in marginal areas and appreciation is ONE THIRD to HALF your net return over
time, besides monthly cash flow. Be wary of foreclosures. They may or may not be a
good deal but EVERY agent I know says it’s a MAJOR pain dealing with banks. If often
takes MONTHS to get an answer back on your offer, yes months! There is usually lots
of non-foreclosures in your price range so I say, “why deal with a bank?”.
I recommend against having a partner in your venture. If you own something yourself,
YOU make all the decisions. Some partnerships work out, but a LOT don’t. It can create
a lot of hard feelings and lost friendships. Once you’re in one, you’re in one, it’s too
late… If you must have a partner, think twice (or maybe three times !). Don’t use a
friend or family member, you’ll regret it, trust me. Your partner is just that, a business
associate, not your “buddy”.
Loan:
I recommend getting a fixed rate 30 yr. loan because this maximizes cash flow (profit
after all expenses) which is the holy grail of investing. A 15yr. note does pay off the
house faster but the payment is fixed AT A HIGH LEVEL. With a 30 year note the
payment is lower and YOU have the option of making extra payments if you want to (to
reduce the note balance).
Paying off a house is nice but shouldn’t be your goal. MAXIMIZING CASHFLOW IS
YOUR GOAL. REPEAT: MAXIMIZING CASHFLOW IS YOUR GOAL. Never
forget that. Ever… (when a bank looks at you they don’t care how much you’re worth
or how much equity is in your properties, they want to know WHAT YOUR MONTHLY
CASHFLOW IS because that‘s how they know they‘ll get paid back !). Notice I didn’t
say “monthly revenue”, I said CASHFLOW, which is your NET after all expenses.
Making extra payments may pay off the loan sooner but that money is now locked away
inside the property as illiquid “equity”. It may make you feel good but it won’t help you
in any way and its rate of return is ZERO. You can’t use it (unless you refinance, which
is expensive). If you want to make extra note payments, make them into a safe liquid
investment instead (CDs, cash value life insurance or bonds) and then DON’T TOUCH
IT.
Once you have some equity, I do recommend taking out a heloc (home equity line of
credit). That way, you can get at the equity quickly if you need it. Don’t EVER use
equity to fund your “consumption” desires (e.g. a vacation), only use it to buy
something which will generate income. FYI, Wells Fargo & Compass bank will give
you a heloc on investment property, most lenders won’t.
The more money you put “down“, the lower your payment will be (and the higher your
cash flow) but the less your leverage is. I used to put down 5-10% but I’ve put down
20% at times to avoid PMI (private mortgage insurance) which increases your payment.
For instance, the PMI on a $100k loan could easily be $75 per month ! Many lenders
now want 25% down for rental property !
If you can get the owner to finance the deal, good, (there are no bank fees, which are
high and you can usually put less down) BUT the interest rate is usually higher than
from a bank or mortgage company AND the loan is usually a short term one. You want
permanent financing. Also, I always have the bank “escrow” for taxes and insurance
which means that each payment includes a charge for those expenses so YOU DON’T
HAVE TO COME UP WITH IT AT THE END OF THE YEAR, AND IT’S A LOT
especially here in Texas !
Everything with real estate is negotiable, don’t forget that, EVER.
If you don’t ask for something, you won’t get it. ASK for it ! (if
you don’t ask, the answer is already “NO” !). If the seller tells you
upfront they won’t do this or that, ignore it… (this isn’t true in a
“hot” market but YOU don’t buy then)
Renting the house:
Your property must outshine all your competition ! Families typically go out on a
Saturday and preview houses they want to rent. They’ll check out 3 or 4 in their price
range and will rent the nicest one. Yours must “smoke” the others, hands down. Put
NICE ceiling fans in all the BR’s and LR, house must be spotlessly clean, replace any
worn floor coverings (use carpet ONLY in the BR‘s, if at all), have any worn
countertops recoated, yard must be mowed and edged.
Replace any cheap or worn lights and plumbing fixtures with NICE ones (larger cities
have places where you can buy used and new building materials for cheap, Habitat for
Humanity for instance). Replace badly worn or outdated appliances and make sure they
are all the same color. I never buy new but get 1-3 yr. old ones out of Craigslist or the
newspaper. I replace venthoods with over-the-range microwaves which I pick up all the
time for $25-75 (make sure you get ALL the installation parts including the wall mount
bracket and top mounting bolts !).
I ask potential renters if they need a washer/dryer and I’ll gladly supply them for an
extra $25 per month (you can get nice used ones for $100 each so after 8 months,
they’re paid for) ! BTW, anything you buy for the property is tax deductible so in
reality it costs even less than what you’re paying for it ! How awesome is that !?
Paint the house inside and out if it needs it. Get rid of any bad smells. “Stage” the house
with little doodads inside (like towels on the towel bars, soap dispenser by the sink,
flowers, etc.) Use non-electric deoderizers to give the place a good smell. Don’t scrimp
on upkeep, remember you must SMOKE the competition and there’s LOTS of it! The
better your place looks, the better tenant you will attract. Low quality tenants will make
your life a living HELL, trust me.
Put a for rent sign in the yard and one on the nearest busy street corner. Check the
newspaper to see what homes in your area are renting for. Place ads in as many venues
as you can afford. I have good luck with the newspaper. I also use Rent.com
Do NOT show the house until it is 100% ready, otherwise you’re wasting your time
(people are turned off by houses that need work). I leave my places unlocked and when
people call I tell them to “go check it out”. I leave applications inside and tell them to
take one, fill it out and fax it to me if they’re interested. If they leave and forget to pick
one up, I’ll email one to them. I’ve never had a problem doing it this way. If the home
is in a “bad” part of town (which you shouldn’t be buying in anyway), then put a combo
lock on the front door with the key inside. If a realtor sends me a qualified tenant, I have
no problem paying them a commission (usually 75-100% of the 1st month’s rent). I
rarely do this though as I can usually rent them quickly myself.
I personally don’t mind people with bad credit or a long ago criminal background if they
have a good rental and employment history. I generally don’t rent to people with an
eviction on their record unless it was a long time ago. I also rent to “Section 8” [welfare]
tenants a lot. I’ve had pretty good experience with those programs, and they tend to be
very stable renters AND THE CHECK FROM UNCLE SAM NEVER BOUNCES.
Never rent a property without getting a deposit in cash (never a check) and never allow
them to pay the deposit over time, get it upfront or you’ll never get it! A property is not
“rented” until you have a deposit and a signed lease i.e. keep advertising it no matter
what the people tell you (“I‘ll come by tomorrow with the deposit I promise“). They
don’t move in till you have the 1st month’s rent, in cash, never.
When a house is for rent I usually have the utilities turned OFF after I’ve done the
repairs to save on expenses UNLESS there are dark rooms that people can’t see without
the elec. turned on (usually baths). Sometimes though I’ll just leave a flashlight in there
for them to shine into the bathrooms (“watch your pennies and the dollars will take care
of themselves”). I go by the property every few days to make sure everything looks
good (1 roach or pill bug on the foyer floor WILL scare off some people!)
Selling the property:
In a word, don’t ! Rental properly is a LONG TERM investment. Just because you
have lots of equity in the house, don’t be tempted to sell or refi UNLESS you’re
stepping up to more or bigger properties using a 1031 exchange (selling is where you
incur the most expenses AND taxes.) There’s nothing wrong with staying with sfd
though, nothing at all. They require very little of your time once the tenant is in and
that’s a big point to remember. Multifamily may throw off more cashflow but it takes
more of your time too… Don’t forget that.
When you do sell, consider selling to the tenant using a lease purchase arrangement or
with you “carrying” the note. YOU get the same cash flow as before but without the
maintenance and management headaches…
Managing the house:
There’s not much to managing sfd so do it yourself ! Most property managers don’t do
much and they certainly won’t keep as good an eye on YOUR investment as you will.
Never let the tenants pay late (after the 3rd) & always insist on them paying late charges
if they do pay late. Never become their friend or buddy. This is a BUSINESS
arrangement.
Never let them put their problems onto you (“I can’t pay because my mom’s sick, I lost
my job, I broke my leg“, etc.). That is THEIR problem and THEY have to deal with it.
If rent is not paid by the 10th, you must post an eviction notice on their door, NO
exceptions. File the eviction 2 days later. They’ll get the message loud and clear.
They’ll either pay or move out. Do not listen to their promises to pay; MONEY talks,
BS walks. Do not accept partial payment, it affects your legal rights. They’re just
stalling for time and stringing you along. DO everything reasonable to get them to stay
since tenant turnover is what kills your bottom line but they must pay. I rarely have to
actually file an eviction (very EZ, done at the local small claims court, forms are
online), the people usually pay or move, but you must keep up the pressure on them !
You can always make exceptions for good tenants who are having a temporary tough
time, use your judgment. The bad ones will always lay a guilt trip on you, don’t fall for
it. Tell them you have a mortgage to pay and that you are not a charitable organization
but a for-profit BUSINESS.
Keep the rents at market rates so keep abreast of what the market is doing. I raise rents
approximately every 18 months. The tenants never complain because they KNOW what
other houses nearby are renting for, trust me! If you keep the place fixed up, they’ll
stick around because they’ve all had crummy landlords who fixed nothing and STILL
charged them market rents !
I rarely return the deposit because most of the time they break the lease or leave the
house dirty. If they leave it clean though, return the deposit. That’s the right thing to do.
I always take pictures of a dirty house in case they try and come back to me for the
deposit.
Repairs:
Tell the tenants to call you right away when something needs repair and then fix it right
away. Try and do it yourself, most items really aren’t that hard. If you can’t, call a
professional but not just anyone.
ONLY use people you have gotten a referral on and then establish a longterm
relationship with them and pay them promptly. They’ll take care of you in a pinch that
way. (It’s Saturday and I just got off the phone with my a/c man who is in VT on
vacation. He told me he’d take care of the problem and he DID, he called a friend of his
to service my tenant’s a/c within TWO hours!). You want plumbers, handymen and
electricians like this too. Get referrals from friends, Angieslist.com or property
managers (they REALLY know who’s good and inexpensive)
When a property goes vacant, fix ALL the problems inside, repeat: ALL the problems.
This makes it easier to rent and reduces calls from tenants once they’re in the unit.
When I DO go by a house for repairs after it‘s rented, I always check the a/c filter, the
smoke detector and the gfi outlet in the bathroom or garage (to make sure it still trips off
when tested). If the filter is dirty, I tell the tenant it’s really increasing their electric bill
and if the unit stops cooling due to a clogged filter, the repair bill is THEIRS (says so in
the lease). I really “lay into them” if the smoke detector is disconnected, especially if
they have children!
The downside:
There are lots of stories out there regarding “bad” tenants who destroy your property
and cause a lot of problems. They are few and far between. Most people are decent and
just want a place to live their lives normally. The secret to avoiding them is to SCREEN
everyone carefully. Call their boss, call their landlord, listen to them and look at them
(avoid people who are evasive, vague or give incomplete answers). Make sure their
“boss” or “landlord” isn’t really one of their friends. Insist on a completely filled out
application. It’s better to have a vacant unit than to have a bum tenant. If you catch them
in a lie, don’t rent to them.
People who are “in a hurry” to rent or who have to “move in this weekend” are probably
being evicted or otherwise in a bind of their own making and are a risk. Do check out
their stories though and exceptions can always be made. If you don’t have a good “feel”
for people, have someone else meet them and talk to them and see what they think.
Having rentals does involve a lot of bookkeeping especially right before April 15th. You
must keep ALL receipts for all of your expenditures so you can document everything if
you’re audited. This business is for ORGANIZED people. If you’re not, you should find
something else to do.
Rentals throw off income which you have to pay taxes on and if you don’t make
quarterly payments to the IRS, you have a BIG payment due on April 15th. MAKE
QUARTERLY PAYMENTS (or have extra tax taken out of your paycheck by your
employer to cover the additional tax liability) ! Use IRS form 1040ES available on their
website.
Emergencies do come up. You may get a call on a weekend or at night with a real
problem which you need to deal with right away (plumbing leak or dead a/c come to
mind). YOU need to go over there and deal with it or know someone who can (this is
why I only buy realty in the city where I live). It also allows me to drive by
occasionally and check things out… If you have property somewhere else, you have to
pay someone to manage it and there goes your profit !
If you get sued by someone, (not just a tenant, which will almost never happen) and
lose, the plaintiff can put a judgment on your property so never have it in your name,
(use an LLC, corporation or Limited Partnership) setup by a lawyer experienced in this
area.
You DO have to evict people sometimes and it’s not very fun but it’s part of the
business. It is stressful going into a courtroom to confront someone. It rarely happens
though because most people do pay on time and if they don’t, they usually will move
out before the sheriff comes, but not always.
The secret is to deal with problems (i.e. late rent) immediately and work with the
people, do NOT let the problem fester and drag out, it’ll only get worse believe me. I
emailed a tenant today (Saturday) and told her if I didn’t get rent by tomorrow, I WILL
post notice on her door on Monday and I WILL file an eviction 2 days later. That way
they know you’re not just kidding around. But you must follow thru !
Investment property does have its rewards but it involves real WORK, some hassles
and the occasional nightmare but overall it’s a fairly EZ way to build wealth and
generate income, give it a try !
For lots more info, check out this website: http://www.nolo.com/legalencyclopedia/
landlords/index.html
