Commercial Real Estate Investing vs Residential Real Estate Investing
A Video Series
You know the saying, the grass always looks greener on the other side, right?
As you deal with another tenant turnover, surprise repair request or increasing tax and insurance costs, it’s easy to think that a five year triple net lease* is a better way to invest in real estate.
But, there are some really significant costs and risks associated with doing commercial real estate deals.
As we just closed on the biggest deal we’ve done to date (a multi-million dollar medical services building), we thought we’d put together a video series to help you decide if commercial investing is right for you, and how to handle some of the common pitfalls if you do it.
If you’re staring longingly at that green grass on the other side of residential investing, we hope these videos help you decide what investment vehicle is right for you today.
*a triple net lease is basically where the tenant is responsible for most of the costs of operating and maintaining the property including taxes, insurance, maintenance, and property management
How to Set up Your Bank Accounts with a Growing Real Estate Portfolio
We answer a submission from Gary around banking and what we do with our bank accounts when our real estate portfolio is growing. When you have multiple properties and you have multiple joint venture partners, there’s lots of different things going on. In Gary’s case, he actually has what I deemed as a fairly complicated system of sub accounts of the sub accounts. And it got rather confusing for me. So this is for anybody out there that has more than one property and in most cases, if you have joint venture partners that you own the property with. We will be following the system that we use and that we generally recommend to most people.
A disclaimer, this does not include anybody that manages other people’s properties. They are only for properties that you own or you co-own with other people. I just want to make sure that you’re aware of that its not for property management.
What we do with our bank account systems:
It’s a main business checking account with a bank. It could be any kind of bank that you can do checks with, email, money transfers, that sort of thing.
Then we set up specific property accounts for each property. Example; property one, two, three, four, as many as you want. Each of those property specific accounts are just basic personal checking accounts.
I am personally on the account and his joint venture partner is on that account. We both have access. The key is making sure you explaining to your joint venture partner that they’re not to do anything with that account without checking with you first because you’re the managing partner, I assume you are in most cases. It’s not an account for you guys to play around with to transfer money whenever. You want to specifically only give them access to it so they can see what’s going in, what’s going out.
Any bills coming in and money going out. Each property specific account you put your rent check into, transfer the money in or however it works for that specific property. The mortgage comes out of that account, whether the mortgage is in your name, a business name or your joint venture partners name. The money comes out of that account.
To write a check for a tradesman or some somebody that doesn’t take a a visa card, we’ll write the check from our main account. We’ll track what the bill was for, right on the receipt, which property it’s for, and then we will transfer the funds from that property back to pay ourselves back. And we just track that with, QuickBooks, Excel spreadsheet, whatever you use to track your expenses. For instance, if there was some job that had to be done at this property, say some plumbing went and I had to pay a plumber with a check, I’d write the check from my main business account that go to him or her, the plumber, and then I would just transfer the funds from our property that we did the work on to pay myself back.
I have a business credit card and that business credit card basically acts like this as well. So the business credit card, I’ll pay for any number of these things and then I just pay directly online from the specific properties account to pay back that credit card.
That is how the flow of money works. The key thing to all of this is that these are just personal checking accounts and you set them up, you get your joint venture partner added on with you so they have access to it too. When it’s time to pay them out, your going to pay them cash flow from it, what I do, I don’t write them checks. I tell them how much money they can take out of the account and then it’s on them to take that money out. This is the system that works for us, we control everything, but our JV partners do have access to it.
In terms of banks, there’s no one bank that’s better than any others. We actually have several accounts with one bank. We have another several accounts with another bank. We have about four different banks that we deal with. There’s no one bank that’s better than any others, but that’s our system. That’s how we work. We found it works really, really well. It’s great for tracking purposes and I highly recommend you do something similar with your own system. I hope this gives some advice to a variety of other people that are looking for how do you do your banking when you have multiple properties and partners.
Do you want to access a massive amount of money to fund your deals?
I believe this is the largest untapped source of funds available to us because very few people actually know this option exists.
It doesn’t always make sense for you to use RRSP funds to finance your deals, but it can be a fantastic option for you.
Master this and you’ll always be able to find the funds for your deals. A mortgage can be held in a self directed RRSP account and when you tell your potential investors this they just might be surprised to find out they could be making money like a bank with funds in their RRSP account. With no management fees or advisor commissions to pay, RRSP holders could be making a stable and predictable 6, 7, even 10% or more return on their money inside their RRSP.
How many people do you know that have delayed retirement plans because of a sudden dip in their retirement funds thanks to a swing in the markets? When holding a debt obligation in your RRSP fund you have a lot more control over the risk, you have a say in the return you get, and you actually have recourse if you aren’t making the return you were promised.
Today, Dave’s put together a couple of videos to help you understand how to use RRSP mortgages to fund your investments.
7 Steps to Use RRSP Mortgages to Finance Your Real Estate Investments
Now that you have an idea of how they work, here’s when you might want to use them and how much you will likely have to pay a lender if you borrow their RRSP funds.
When To Use RRSP Mortgages
Have questions or comments? Posting them below the videos in YouTube or popping over to our Facebook Page are the best places to ask and get answered!
Want the only resource you need to use RRSP Mortgages?
We double our money in real estate almost every year.
That’s not really a fair statement though. MOST of our direct financial investment in our deals is limited. What we invest in our deals is our expertise, time, tons of time actually, and my team which has taken me years and years to build. The value I bring to the deals isn’t financial. We typically put in less than $5,000 on each deal and in most cases I get that back in the first year, if not double it. Our Joint Venture Partners, however, will have to wait about 5 years for their money to double but they are doubling a $70,000 investment not a $5,000 and, more importantly, their return on their time is infinite (as they only have a few hours of due diligence and writing the cheque).
So, when a writer for Canadian Real Estate Magazine interviewed me looking for my tips on how other readers could double their money in three to five years I found the question tough to answer. It really depends on what ROLE YOU WANT TO PLAY.
And, to be really frank with you, Julie and I invest $30,000 to $40,000 a year into coaches, courses, networking and mentoring and have done that consistently for several years now. We also have costs like our office space, our office manager, office materials, websites, marketing materials, parties and other expenses that aren’t directly applicable to a specific deal but are all business expenses we incur as part of generating the income we do with our real estate. So we don’t REALLY double our money every year (although it is growing beautifully!).
Assuming you do want to be the active investor like we are, here’s our formula to finding the deals that are going to be most likely to double the initial investment required in 3 to 5 years – whether you’re doing this with a partner or on your own. Our model for buying rental properties is simple. We only buy properties with a CAUSE:
Convenience: Is the property near schools, hospitals, shopping, public transportation, a university – the more convenient the location, generally the more in demand it will be both for renting and for selling in the future. It also increases the potential rent rate and the quality of the rental pool we’ll draw from.
Attracts families: Areas that attracts families and that fit all the other CAUSE categories tend to be the easiest to rent, with less turnover, and lower maintenance and lower risk.
Under the average price: We focus on buying homes that are 10% below the average price in our chosen market. Why only 10% below? Because if you go much below that you tend to get into tougher neighbourhoods and rougher houses – and just because we buy in areas that are 10% below the average house price for our city doesn’t mean the houses we buy are only 10% under – we’re bargain hunting!!
Starter home: Determine what type of home in your chosen city/market is a starter home (single family detached house, townhouse, condominium) and then buy those types of homes. This is the entry level home and tends to be the most liquid, most price stable and generally the easiest to rent out too. People move up from them and down into them.
Economic fundamentals: Find a city that you are near and that has good market fundamentals (people are moving there, more jobs are coming, amenities and infrastructure are growing, government is pro-business, rent rates are stable or increasing).
Once a property meets all the criteria above, we do the following:
Find someone looking to make a great return in real estate without having to invest the thousands of hours we’ve invested to become experts, and use their money and finance-ability to close on the property.
Find great tenants, manage the property and enjoy the benefits of mortgage pay down, cash flow, and appreciation.
The big thing I want to point out is the fact that so many people get hung up on finding the perfect investment market. The market we’re investing in does not have perfect fundamentals but no market ever does (even the coveted Edmonton market which so many investors run to does not have perfect fundamentals). We’d rather become area experts and stay focused where we are and know that we can control our investments because we’re nearby.
By doing deals just like the two we show below, even if you put in all the capital yourself you will double your money over 5 years, easily. But, you have to focus on buying properties with a CAUSE, otherwise you might end up going through the pain we went through as early “quick cash” investors!
Two recent deals we have done:
Property A: Purchase Price: $321,000 Cash required from us: $10,000 Cash required from JV: $75,000 Rental Income (Rent To Own): $2,750 All Expenses: $1,300 Net Cashflow: $1,450 split between us and JV Partner When Tenant purchases in two years, total cash return will be: $50,000 split between us and JV Partner ROI on our $10,000 = 250%($25,000 / $10,000) over 2 years
Property B: Purchase Price $303,000 Appraised Value: $330,000 Cash required from us: $4,000 Cash required from JV: $70,000 Rental Income (Buy and Hold Rental): $1,650 All Expenses: $1,300 Net Cashflow: $350 split between us and JV Partner If property appreciates, on average only 3% per year for next 5 years, total cash return will be: $110,000 split between us and JV Partner ROI on our $4,000 = 1,375%($55,000 / $4,000) over 5 years
We are just about to lift conditions on a beautiful 4 bedroom 2 bathroom home sitting on a quarter acre lot in Nanaimo. The home has nice high end finishings throughout including heated floors in the main bathroom and kitchen, beautiful hardwood floors and crown mouldings. It’s lovely. It’s so nice, in fact, that our home inspector said “You paid WHAT for this place??”
He was shocked at the price we purchased this home!
In the past we were able to find deals that cash flowed. We even picked up properties for under market value. But I would not say that we were identifying and negotiating deals that were significantly under their market value like this one. And the reason we’re able to find smoking deals like this one is because of my new secret success weapon. It’s a weapon we’ve deployed in the last 18 months and it’s resulted in an enormous change in our business.
The weapon is so deceptively simply I hesitate to even share it with you …
The weapon is focus! Or as our 12 Months to $1 Million club members hear us prattle on about week after week, it’s about BEING AN AREA EXPERT.
It’s not about chasing deals all over the countryside –it’s about finding an area that has good market fundamentals and that you can spend time and energy getting to know fairly easily.
When we share this with people at club meetings, in group coaching calls or even with friends they exclaim how much work that is. And I am certainly not going to try and convince you that it’s not work because it is. It takes a few hours invested weekly over at least three or four months before you can really begin to call yourself an area expert. It takes market watching, researching the sales stats, open house visiting, viewings, conversations and drive by’s. And most of all it takes some patience.
Here’s the thing that I think most people are missing though … and that is the fact that the deals you’ll find in Arizona, Florida or the East Coast of Canada might be cheaper and have slightly better cash flow than the deals you’ll find closer to home … but the question I ask you is: WILL YOU FIND THE BEST DEALS?
I can say with 100% confidence we’re finding deals that fit perfectly within our investment plan – they deliver us monthly cash flow, our partners 15% – 20% annual ROI on their money, and they build our wealth. I can also say that we are finding the absolute best deals in our market area given the strategies we use.
Are there other deals? Yes. Are the deals we find the only deals? Heck no!
But when we can buy a large home in great condition, on a large lot, and have real estate professionals telling us how impressed they are with our purchases (and the prices we get them for!), we know our secret weapon has been launched and is hitting it’s target.
So –what can you do to launch your own secret weapon? Ditch the deal chasing … settle into shopping in an area nearby where there are jobs, schools, transportation options, recreational amenities and more people moving in than are moving out. With that selected, get even more specific and:
Pick a property type. For example, we focus on homes that are a minimum of 3 bedroom and 2 bathroom. We do not deal in ranchers unless they are over 1500 square feet. Homes must have a usable back yard. Ideally not older than 1970 although we will make exceptions for homes in great condition. Depending on where you want to invest you may want to focus on condos, townhouses or smaller homes. The safest property type to go with are homes that fall into the starter homes category. Every area has a home type that is considered a starter family home – find that home type and price range and focus on it. There is always a market for starter homes – in good times and bad. They are the most liquid homes in any area.
Pick a smaller area or two within your city of focus. This is the game changer. It’s pretty difficult to become an expert in an entire city very quickly. Different pockets of a city attract different people for different reasons. With different features, amenities and home owners you find the price points are different. Thus, to truly be able to spot a smoking deal you have to be intimate with a smaller area. You want to spend time focused on a pocket or two of a city that amounts to about 12 – 20 blocks max. That is it. It seems like you’re limiting yourself but really you are simplifying. When you cut out the clutter you can spot the really good deals and act quickly before everyone else wakes up to the price point (which is what happened to this home we’re about to get firm on … Julie saw the price drop and said it’s time to move on that one. Sure enough we saw it, put in our offer, and all of a sudden it’s getting shown like crazy but we had moved quickly to lock it up before anyone else did).
Spend time getting to know the properties that fit your criteria in your sub market. We probably went overboard as we physically viewed nearly 100 properties in the last six months. Online we probably looked at 5x’s that number. But we know the market very well now. There are very few real estate agents that know the market as well as we do now. And that is how we can spot deals that are on MLS and worth $40,000 more than we’re buying them for – without putting any money into them. Instant equity thanks to this secret weapon.
The final ingredient isknowing which strategy to use in your target area. Some areas that we focus on won’t cashflow well as a regular Buy N Hold but they will work beautifully as Rent to Own’s. And in another area, a Buy N Hold strategy is perfect because the prices are 10-20% lower but rents are only 5-10% lower than higher end areas. So when you are picking 2 or 3 locations within your target city/market to specialize in, know what strategy will work there. And how do you know what strategy will work in your chosen area(s)? Well, that’s a whole other article, but simply said, you’ll know because you’ll have done your research on rent rates in that area, how many For Rent signs you see there, the type of people that live in the area (are they blue collar, white collar, immigrants, students, etc.), and the property types in the area (multi-units, single family homes, starter homes, luxury homes). Knowing the answers to all of those categories/questions will help to define which strategy is best used there.
This weapon is simple but it’s deceptive in it’s simplicity. The hard part is not getting distracted when someone starts telling you about a hot deal they found in another market or the deals you’re hearing about in US sunny states. The really hard part is staying focused. Trust me – I know! But now that I know how powerful my secret weapon is I am finding it so much easier to turn away from the juicy sounding commercial deal someone sends me or the fix and flip potential of a deal in a different market. I remind myself that I can work less and make more just sticking to what I know and know very well. Plus my wife not so gently tells me to stay focused … that helps too.
Most of the real estate investors we’ve met that are selling all their property are usually doing it because they are tired of dealing with tenants. It’s the same reason a lot of people we know are scared of becoming real estate investors. They have heard horrible stories of bad tenants. And we totally understand. When we had bad tenants we had many conversations about selling everything we owned and getting out of the real estate business.
Most of the people that contact us with hard to rent properties or bad tenant stories have made one of two mistakes. They’ve bought a property that doesn’t easily attract good quality tenants (or bought a property with bad tenants in place) or they made an exception to their tenant selection process and let someone move in that should never have been approved.
We’ve had all of these problems happen to us. We eventually just sold the properties that never attracted the good tenants and started following very strict tenant selection criteria. No matter how anxious we are to get cash coming in on a property we won’t deviate from our criteria. We know how badly that can go so we’ll happily wait another month to get the right tenant in a property.
And you know what? It’s working really well! Our tenants aren’t perfect but most of our tenants are pretty awesome! They care about the home, take care of it, pay their rent on time and respond to us when we need them.
So what do you need to do to select the best tenants from your pool of applicants? Here’s a checklist to help you.
Tenant Screening Checklist
1.Tenant Application with Signed Consent permitting you to do a credit check and reference checks (you may also want to have a separate letter signed by the prospective tenant authorizing you to verify their income from their employer).
Most states and provinces have application forms that are ok to use for that area or a local landlord association will usually have one you can use that is legal for use in your area. We also recommend you have each person over 18 that is going to live in the home complete this form and provide you with their consent. And make sure all children and pets that will be living in the property are named on the application and in the lease (with their birth dates).
2. Confirm their identity by asking for their Provincial or State Issued Drivers License. We usually snap a photo of it so we have a copy for our records. The big thing we look at is that their license confirms they are who they say they are and that the address on the license matches the address they’ve given us and shows up on their credit report!
3. Credit History: The score matters but it’s really not just about their credit score. You want to use the credit report to see if they are generally responsible with their use of credit, if they have a bunch of people after them for payments, and if there are any gaps in their credit history which could be an indication of a bigger issue like incarceration. If someone has filed bankruptcy in the past that doesn’t mean we wouldn’t take them as a tenant. What’s more important to us is what they are doing with their credit and their finances AFTER they’ve filed for bankruptcy. If they have filed bankruptcy in the past and again are in financial trouble then that is a giant red flag for us.
4. Income and Employment Verification: This one is tricky because an employment letter is easily forged, and many of the larger companies or government affiliated companies will not tell you anything about an employee. Even with the written consent of their employee they still will not tell you anything except to verify that person works at the company. So this one is not always straightforward but here are a few of the things we do to get as much information as possible.
Google the name of the person in quotes. For example“Dave Peniuk”. If hundreds of results come in, specify a city. Type in“Dave Peniuk” Burnaby. Sometimes you’ll find a reference to the person on a company website, a LinkedIn Profile, a Facebook Profile or some other online page that can give you more information and possibly verify the information you’ve been given.
Find a number for the company they work for using the phone book or an online search.We never bother to call the number the person gives usto call because there is no way for us to know that it’s not just a friend’s cell phone. At least if we track down the company number ourselves and get to the person who can verify that the tenant works there we feel pretty confident that part of the application is true.
Ask for a pay stub to verify the income if you’re concerned. Keep in mind that painters, servers, and other service professionals may actually collect a lot of their income in cash so their pay stubs may not be a real indicator of their income.
5. Rental History: Basically you want to see how often they move. If they have moved a lot then, unless there is a good reason the moving will stop, you can expect a short term tenant. You also want to make sure that all the information you have checks out with where they say they’ve lived. Finally, look for gaps. If you discover an address is missing or there is a time period where they don’t have an address listed you’ll definitely want to find out why they didn’t disclose it. Was there a dispute with the landlord? Were they out of country? Or were they somewhere that they didn’t want you to know about?
6. Do they have a story? This is a BIG one. The most troublesome tenants we’ve ever had have been the ones that had big stories right from the beginning. If you have a tenant with a story listen carefully to the story. Are they blaming other people for their situation? Are they giving you a big story about their last landlord being evil? If you’ve asked about gaps in their employment, missing addresses in their history, or a credit issue and the answer has been a story that sounds a lot like it’s all someone else’s fault then you probably want to run quickly in the other direction.
7. Do they do what they say they are going to do? The best tenants show integrity and accountability from the start. Do they show up to see the property on schedule or maybe even a little early? Do they deliver the application and deposit when they say they will? Do they return your calls or emails promptly? Tenants that do not do these things in the beginning will never do these things later on. And tenants who ask for a bunch of exceptions and make you work super hard to convince them to rent from you are usually the first ones to complain, first ones to ask for exceptions when they make a late rent payment and the first ones to cause you a ton of grief. Look at how the tenant is behaving and ask yourself if this is someone with integrity, accountability and respect for others? If they do what they say they are going to do you’re off to an excellent start!
You may be wondering where references are on this list. It’s not that we’re saying you shouldn’t check references but we don’t put much weight in references. If someone asked you for references are you going to give them a nice cross section of people to call or are you going to give them the best people? And landlord references aren’t usually worth much either. Right or wrong, we only half-heartedly check landlord references. Mostly we just ask for landlord references to see what the tenants will say. The reality is we’ve found that current landlords never say anything to deter you from renting to someone so we rarely bother to call.
Even if the tenant is bad the current landlord is not likely to say so – after all they want them to move out! We will call past landlords (that is, the landlords before the current one) because they may be more up front given that the tenant is not trying to leave their premises right now but we usually do this as a final check, after we’ve gone through everything else. By this time we’re pretty confident that the person will make a great tenant, and the past landlord usually just verifies that fact.
Hopefully by using this checklist you’ll have an easier time screening your next tenants. And with better tenants we’re pretty sure you’ll be a much happier investor!
This week a woman other than my wife, Mom or sister told me she loved me.
I had just called our partner to let her know that everything is lining up nicely for our tenants to buy the home that my partner and I own. I told her that when they do that she will have earned about 18% on her investment in 13 months.
She exclaimed “Dave, I love you!” And when I asked her if she had any plans for the money she quickly said, “Let’s do it again.”
She’s obviously happy with the results and with the partnership. And that is because she chose her partners carefully. In her case, she focused on the people she was investing with not the deal. She didn’t do much due diligence on either of the deals she has done with us (and we doubt she’ll do much on the next one we’re doing together either), but she did do her due diligence on us. She told us right from the start that she was giving us her money because she trusted us, felt confident in our expertise and liked our rent to own program. And for her, a return was important, but it was just as important that she not have to do anything at all to earn that return. She wasn’t interested in throwing her money into a mutual fund and hoping for the best but she’s a busy business owner and triathlete and she doesn’t want to worry about her investments (nor about tenants and toilets!).
And, honestly, the most important thing you can do is find good, experienced and trustworthy people to invest with. I, personally, suggest that you check into every deal you’re investing in as well, but at the end of the day it’s the people you have to trust and believe in because they are the ones that will make the decisions that will either make or break the investment.
Where to Find Joint Venture Partners
These days the easiest way to find prospective joint venture partners is to do a search online. Most of the folks running an investment business like we do have a website or blog dedicated to explaining the types of deals they do and providing some sort of education and information. You could do a search for real estate investment opportunities and your area to find someone local.
But, personally, I think the best way to find someone to invest with is to drop into a couple of your local real estate investing club meetings and ask your friends and family if they know of anybody successfully investing in real estate.
Once you find a few different people meet with each of them. You’re investing as much in the person as you are in a specific deal so you want to make sure the person you’re investing your money with checks out.
What to Ask Your Prospective Partner (& yourself!)
Does this investment fit my goals? In the case of our partner, the most important thing to her was to get a good return without having to do any work once the papers were signed. We offered that solution for her so it was a perfect fit. If you want to learn about real estate along the way you might want to find a partner that is willing and able to teach you as well as invest your money. If you really want to be hands on with your deals then you will be looking for somebody that will work with a hands on partner and perhaps give you a greater share of the deal in exchange for your efforts. You have to know what is most important for you – and then check whether this prospective partner and the deals they are doing will fit with your goals.
What is your track record? Past performance doesn’t always indicate future success but how this question is answered can tell you a lot about someone. We’ve earned one of our partners over 700% return on his investment in six years. We also earned the same partner 110% on another investment in five years. When I am speaking with joint venture partners I rarely mention either of these examples because I don’t want to set expectations that high when much of that return was thanks to a rapidly increasing market. Sure – I did the research to know those areas were poised for growth but I had no idea they would sky rocket in value! Instead I will tell prospective joint venture partners that I have never earned a partner less than 15% per year. I will tell them that there are no guarantees in anything, let alone real estate but because of x, y and z I feel pretty comfortable suggesting a 15% – 20% return on most of the investments we do is very likely. Listen carefully to how someone answers this question. If they tell you about their best deals and don’t mention the worst, dig into the bad deals they’ve done to get a sense of how they have learned from their past experiences. And to get a sense of how honest and upfront they are. Look for a decision making process and an ability to take responsibility for the bad deals. That’s far more important than finding someone who made a 700% return on someone’s money one time.
What is your credit like? Can I get a copy of your credit report? We’ve said this repeatedly at Rev N You – if you can’t manage your own finances then how can a partner trust you to manage theirs. So if you’re someone looking to turn your money over to someone else I think you have every right to understand how your prospective partner is managing their own money. We no longer qualify for bank financing but it has nothing to do with our credit scores. Both Julie and I have excellent credit scores and would proudly show any partner our credit report if they asked – but nobody ever has. But personally I would never trust someone else with my money if they can’t even manage their own. Nobody loves MY MONEY as much as I do so if somebody else isn’t loving their own money how can I feel comfortable they will give mine the attention and care it deserves?
Do you have references? Ask to speak with one or two of the people they’ve partnered with before. If they’ve never partnered with anyone you could speak to present or past coworkers. I believe a good indication of how someone will handle themselves in their investments is how they handle themselves at work. If they were good decision makers and got along well with others at the office then there is a very good chance they will get along well and make good decisions on your deals.
What to Find Out About the Deal
The majority of our partners get high level details about the deal(s) we are investing their money in, but most of them never go out to see the property. As their partner, I am fine with that, but as your investing coach I highly recommend you ALWAYS go and check out the deal yourself. It’s not about second guessing the expertise and experience of the person you’re working with, it’s about covering your butt. Remember – nobody is going to love your money as much as you do – so make sure that what you’re investing in is exactly what you think it is.
Look at the property to identify work that might be required in the near future. Walk the neighbourhood to make sure it’s a good market to invest in (does it meet the Market Research Checklist items?). And ask any questions you might want to know about how the property will be filled with tenants (who is doing that, how do they screen tenants, what do they look for in tenants).
Finally – determine if there are alternate exit strategies for the property.
Right now we’re focused on rent to own deals but all of the deals we’re doing will be at least neutral cashflow even as a regular rental if it comes to that, and many of them can be sold at a break even point as well (because we bought them under market value and have done a bit of work to increase the value). So we have other ways out of the property if, for whatever reason, our original strategy for the place doesn’t work. Make sure there are options for your deals too.
Other Details to Consider
We’re creating an entire program on partnering for profits because there are so many items to consider when you’re doing joint ventures but in addition to everything above here are few things I think MUST be in place on every joint venture agreement:
A written joint venture agreement prepared by a reputable and real estate specializing lawyer,
An agreement as to how long (approximately) everyone commits to be in this deal – with the understanding that things do change and some sort of clause in the agreement explaining how an unplanned exit from the partnership is to be handled,
Clear expectations of roles and responsibilities for the partnership,
How often and what will be communicated – because everyone’s idea of good communication is different.
If you want to invest in real estate and want to get your money working for you while you learn, finding someone with experience to partner with might be the perfect solution. However, you have to make sure you’re getting what you need from the partnership. Joint venture partnerships work best when everyone brings something to the table. Whether you’re bringing money, expertise or some other important resource to the table, it’s important to understand what you want from the deal and what the other person is going to provide. And do your due diligence. Because nobody loves your money like you do!!
Alright, I confess, this wasn’t my original idea. I actually stole the idea from one of my real estate mentors, Jim Randel. Jim is author of one of the best real estate books out there Confessions of a Real Estate Entrepreneur. He is also writer and creator of the Skinny On series of books. These books can be read in less than 2 hours and are full of fun stick people sketches and easy to understand concepts but they pack a punch full of information.
I read Jim’s weekly newsletters and a recent one was about “10 Reasons (Some) Entrepreneurs Underperform”. It got me thinking about the reasons real estate investors underperform.
Now, this is not a scientific study. I did not go out and survey 5,000 real estate investors and determine who were successful and who were not and then look at the characteristics that shape their success (or lack thereof). This is based on years of investing ourselves and what we have learned from other successful real estate investors.
If you lack these traits (or characteristics), there is a good chance you will underperform as a real estate investor. You don’t have to have ALL of these, but the more you have, the more likely you will be highly successful.
So, without further adieu, here are my 10 + 1 Reasons Why (some) REI’s Underperform.
1.Passion – I feel strongly that if you have passion, real passion about real estate (and investing in it), you will perform better than if you don’t. We know quite a few investors that are not passionate about real estate that have been successful but they feel worn out and want to leave the business. The only reason they don’t leave is because it’s making them money … but they aren’t having fun and they aren’t making as much money as they would (I think) if they were passionate about it. Besides, why spend so much time, energy, focus, and money on something you don’t love? Life is too short!
2.Mental strength– There are so many times where you may want to just give up because you’re doing so much heavy lifting mentally. Challenges like insurance issues, and property financing troubles, and tenant challenges are part of the business of real estate investing – be strong and you’ll do well. And by the way – the more physically fit you are – the better you’ll perform mentally. That’s a fact that has been proven by scientific study.
3.Belief– No one, and I mean no one will (or should) believe in you as much as you do. If you don’t really believe that you can be a successful real estate investor, then you may as well stop trying. There will be times when it seems like you are the only one that believes in what you’re trying to do so you have to be there for yourself! You should also surround yourself with folks that believe in and support you … but that’s a different point.
4.Guts– You have to be willing to go the opposite direction from the rest of the people you know. You have to be able to make your own decisions and have the guts to take action on them. This is not an easy thing to do especially when you first start out. And, to continue and advance as an investor you will still need guts to try new real estate strategies and techniques. In fact, we are working on several creative techniques right now and believe me, my guts are rumbling and churning as I push myself to get’r done. The more guts you have, likely the better you’ll perform.
5.Integrity– Sadly, I have met many folks who have become successful without integrity but I believe that their success is likely only financial. I am confident they don’t have the relationships nor the personal satisfaction that comes with doing business with integrity. Doing business in a way that treats everyone with respect in turn makes you easier to respect and like … and makes it easier to attract the folks that will help you grow your business.
6.Focus– This is probably the most underrated trait or action for becoming successful. If you lack focus, it is still possible to become successful. Heck, over the years I have had trouble staying focused but I have still performed fairly well in the REI game. But, my lack of focus has certainly played an important role in keeping me from reaching my full potential. And, the best part about focus, along with most of these other traits is you can learn it/them! In fact, Julie’s been helping me to re-train myself to become (and stay) more focused! I am getting better all the time (at being focused) and our achievements are moving in sync with our focus.
7.Communication– If you dislike talking to people, emailing, or just all around don’t communicate well with others, good luck performing and being successful with real estate. You have to communicate constantly with realtors, mortgage brokers, banks, accountants, lawyers, vendors, buyers, tenants, appraisers, inspectors, contractors, the list goes on and on. If you aren’t at least somewhat effective at not only getting your point across but also being a good listener and understanding others, forget about being in the REI game.
8.Hustle– Lining up your joint venture partners, obtaining financing, managing all the appraisers, inspectors, realtors, placing and showing tenants the property all require a large amount of hustle. Sure, you don’t need to hustle 365 days a year to perform well, but you sure better be able to hustle every time a deal starts to come together!
9.Commitment– Are you committed? Really committed to being an amazing investor? Are you making it a priority everyday that you do something that will move you towards your goal of being a real estate millionaire? Now, you don’t have to do something everyday, but your level of commitment is directly related to becoming better, stronger, faster, smarter, and wealthier. No commitment = Little to no payoff.
10.Persistent– In my humble opinion, this is absolutely the most critical reason why some real estate investors underperform. If you want to succeed in this business, you HAVE to be persistent. You will find the best deals by continuously following up on opportunities. You will secure the best financing by continuously trying to find a better option. If your partner backs out at the last minute you have to pick up that phone again and again until you find a new partner. Keep trying, keep pushing, keep being persistent. Do not give up.
Support/Network– this is my +1 (of the 10 + 1) reason or trait that is why some real estate investors underperform. I call it +1 because it’s not necessarily within you….it’s those around you. All of the 10 traits I mentioned are part of who you are or who you need to be, but this is those around you. I have yet to find 1 successful real estate investor that doesn’t have a good support group or network around them. This goes beyond your realtors, brokers, insurance agents, accountants, etc. This is the someone or some people who are there when you need them most. They give you that “push” or helping hand when your persistence, hustle, and guts are on empty. This could be a spouse, friend, investing partner, business partner, parent, child, or even mentor. This is one of the reasons we always suggest investors join real estate investing clubs or start investing with a like-minded individual. You will not only learn a great deal from that support person, but you can also look to them for help or guidance when you struggle.
Sure, there are likely several more traits that you need to have to rise to the top of the real estate investing pile, but if you have most (or all) of the above, you should become a successful real estate investor.
“So what do we do? Anything. Something. So long as we just don’t sit there. If we screw it up, start over. Try something else. If we wait until we’ve satisfied all the uncertainties, it may be too late.”
“Think big and you’ll live big. You’ll live big in happiness. You’ll live big in accomplishment. Big in income. Big in friends. Big in respect.” ~ David J. Schwartz, Magic of Thinking Big
What’s the missing ingredient for success for many new real estate investors?
It’s not the lack of vision or a missing plan of attack for the next five years. Nope … most real estate investors start out with giant plans of wealth and success but they seem to fall apart at the first step. In this video Julie Broad talks about the missing ingredient.
As part of our 12 Months to $1 Million membership program we host two group coaching calls per month. We’ve been receiving fantastic feedback from our members, and quite frankly, we really love to chat with our members and help them out with their biggest questions.
One of thing that keeps coming up is the subject of rent to own deals… we kept touching on them for various reasons until finally one person wrote in and said “Are they a good idea?”. So we spent about 18 minutes carefully explaining them and what the advantages and disadvantages are.
We’ve got that excerpt from the call for you to listen to today! It’s 18 minutes long.
In recent years, especially in Western Canada where we live, a lot of real estate investors have found it tough to make the ‘numbers work’ on buy and hold deals. The biggest challenge is finding a deal that you can buy for a price low enough that you can cover all the costs with the rent it will generate.
While home prices sky rocketed over the last 8 years (up to 2008 anyways), rental rates took a slow and steady path upwards.
One of the ways we’ve been able to continue investing in Western Canada and still make money from our investments is to buy properties and then find tenant buyers for the properties. That is, we’ve done a rent to own real estate deal.
The most recent example is from a single family home we purchased in Kelowna, BC.
For our readers that are unfamiliar with how the Rent to Own (RTO) strategy works, here’s a brief summary.
The rent to own strategy is just like how it sounds, a tenant rents your property with the intention (and option) to buy the property at some point in the future (and at a pre-determined price).
To help your tenant prepare for the purchase you charge them a rental rate over and above the market rate with a portion of their rent building up as a rent credit.
For example, if a single family home (3 beds, 2 baths, 2 storeys, good neighbourhood) rents for approx. $1,300 per month as a standard rental unit, in a RTO, the tenant may pay $1,700 per month and $400 of that $1,700 goes towards the purchase of the property (when and if they buy).
Thus, if the renter (known as a Tenant-Buyer) elects to purchase the property after 1 year, they will have $4,800 ($400 times 12 months) towards the purchase of the property. This, coupled with an Option Fee (similar to a down payment) which the Tenant-Buyer (TB) pays to the Landlord at the beginning of the rental period, goes towards the purchase price.
Here’s a quick look:
Purchase Price for Tenant-Buyer:
Option Fee from the TB:
Monthly Rental Credits from the TB:
Net Cost to TB when they Purchase:
In essence, the TB no longer has to come up with $350,000 when they buy the property, they now have to come up with only $335,200 (plus standard closing costs). And, if the Tenant-Buyer is able to obtain good financing, they may only need to put down a few more thousand to make-up the difference between the purchase price and the mortgage amount. This effectively helps the Tenant-Buyer to get into a home and start building equity right away (it’s like forced savings) instead of having to put aside $500, $600, $700 per month into a crappy (low interest) savings account.
So, why would a renter choose to do this option rather than just saving and buying later or even buying now? Several reasons:
1 – They may not have a large enough down payment today to qualify for the mortgage
2 – Their credit may be damaged and so they need some time to correct it to ensure they can get the best rates and terms available (why pay 10% interest with bad credit today when you can build up down payment credits in a RTO, improve your credit and obtain 5% interest tomorrow?)
3 – They want to get into the home ownership market today because they think houses will be too expensive for them a year or two from now but again, they may not quite have the down payment, credit, or even income to obtain ideal financing today
4 – They may want to “test” being a homeowner. Perhaps the renter has never bought their own home and doesn’t know how much work/costs/time being a homeowner can consume versus being a renter. The RTO strategy gives them a feel for being a homeowner, without having to come up with a ton of cash (for the down payment and closing costs) to buy today.
Now, why would you, the real estate investor choose to use the rent to own strategy?
1 – Helps create positive cashflow on single family homes because you can charge higher than market rents
2 – Essentially locks-in your return should the Tenant-Buyer exercise their option to buy
4 – Few extra expenses as your TB pays for regular maintenance costs and any upgrades they choose to add to the home
5 – If the TB purchases the home within 1, 2, or 3 years (the standard option to buy term length), you get your capital back and can turn around and invest in something else
6 – Get all the perks of a standard rental property (tax write-offs, principal paydown by your tenants, cashflow) but you also get a built-in appreciation factor (something a standard rental does not have)
7 – If the TB chooses not (or is unable) to buy the property, you retain all the rent credits and their Option fee (they are non-refundable) and your return on investment essentially doubles. You can then turn around and do another RTO with a new TB
8 – Get an immediate return on your cash through obtaining the Option Fee which can often be as much as 50% of the cash you put in
9 – Potential less worry about what the tenants are “doing” to your property as your TB are essentially the homeowners
10 – If you buy smart, little to no work is required to shape-up the house…it’s already in great condition
11 – Feels good to help individuals “get into” the homeownership market
A Look at Real Numbers: Why we chose the rent to own strategy on the home we recently purchased in Kelowna.
Purchase Price: $351,500 Appraised Value: $355,000 2 Year Option Agreement Price: $383,000 Option Fee from the Tenant Buyer: $7,500 Monthly Rent: $2,000 Monthly Expenses: $1,350 (this includes P&I, taxes, and insurance) Positive Cashflow: $650 per month
So, over the 2 year period, we’ll have earned $23,100 from the Option Fee and the monthly cashflow. In simple numbers, this is a 26% return on our down payment AND it doesn’t include the appreciation built in nor any principal paydown.
Not a bad investment at all, especially considering there will be little we have to do along the way.
One of the things people always say is “What if the tenant doesn’t buy it?”.
It’s a risk (and you should always be analyzing the risk in your real estate deals). But, it’s worth noting that it’s not really a bad thing if the tenant buyer decides not to buy after the 2 year period. At that point we will probably have a bit of maintenance to do on the property and then we will do another rent to own deal on the property. We will get a new deposit, set the new purchase price based on a new appraised value, and we’ll continue paying the principal down on the property with the rent. At that point our return will jump up considerably.
Now, what are the reasons NOT to choose a RTO strategy?
The opportunity to make single family homes cash flow makes this strategy very appealing but it is not for everyone. There are some reasons that a rent to own strategy might not work for you and your goals. Here’s some reasons why:
1 – Smaller population of Tenant-Buyers than regular renters so it may be more challenging to place good, quality TB’s than in a regular rental unit
2 – It doesn’t make much financial sense to pay a property manager to over see a rent to own property given the limited amount of work involved. However, that choice means that it will involved more of YOUR time
3 – If your target market area is in high demand from competitive owner-occupied buyers, you may have more trouble buying good, high quality properties (because there is so much competition)
4 – You have to remember that someone that makes a good renter is not necessarily the same person you’re looking for as a tenant buyer. Your market includes people with bad credit. It also includes people that have gone through some financial challenges because of divorce, job loss or just bad money management. These are people you might not rent to under normal circumstances but you will be considering them as a tenant buyer. Your main concern here is their ability to make the monthly payments. You aren’t as worried about their credit. You want someone that is going to be likely to take good care of the property and can potentially buy it in a few years. You aren’t looking for the perfect candidate that could buy it right now!
5 – If the TB exercises their option to purchase at the pre-set price and property values have skyrocketed since you agreed on that pre-set price, you won’t obtain that large appreciation
6 – It’s still a rental property and somewhat illiquid (compared to stocks, bonds, and other investments).
The Rent To Own strategy is just another tool for your tool belt. It’s not for everyone, but it does make it possible to generate strong cash flow from properties that would otherwise never stand a chance of covering their costs and putting money in your pocket each month.
And the good news is that Rent to Own is really not that different than a standard buy and hold deal.
The tools required to find, buy, place, and manage a rent to own property are similar to a standard Buy and Hold(and so you can apply the principals from one technique to the other quite easily), but this strategy can also give you that “feel good” emotion that comes with helping a prospective homeowner get into the market (and you can profit from that too!).
Marriage and real estate partnerships aren’t that different. There’s a courting period, there are things that each person has to bring to the table to make it work, and there are as many problems as there are possibilities for success.
In real estate investing, just as in a marriage, there are many ways that a partnership can fail. If you rush into a relationship without dating or doing your due diligence you may find that you’re not as compatible as you once thought. You may find that you and your partner end up having different objectives for the relationship. One of you may oversell what you’re bringing to the relationship. Or, maybe things change, and one of you just decides it’s time to move on.
There’s plenty of ways a partnership and a marriage can go wrong. It can get messy and it definitely can be stressful and emotional. And it can happen when you least expect it. And it can feel like there was no warning.
We’re no strangers to turmoil in our real estate partnerships. While the majority of deals we’ve done have been with partners, and they’ve gone very well, there are always new lessons to be learned.
So, if there’s potential for so much turmoil with partners why bother? Why not do all of your deals solo?
Well, just like the right partner in your life can make you happier, more fulfilled and even more successful, the right partner in your real estate deals can allow you to do bigger and better deals with reduced risk.
In fact, the right partner can bring any one or more of these positive things to a joint venture:
Skills and Expertise:For example, if we decided to get into flipping properties we’d be interested in partnering with someone that has experiencing working in the trades or working as a contractor. Someone that has never invested in real estate before may wish to work with someone with experience on their first deal.
Money:Most of our deals involve us bringing our expertise and experience to the deal and doing all the work in exchange for a partner putting up most of the initial capital required.
Financing Options:On a recent deal we were unable to secure the kind of financing we wanted so we brought in a partner who could. Sometimes the best way to look good to a bank is to bring in people that fit into their tiny little box of lending requirements.
Risk reduction:Having additional parties involved in a deal allow everyone to carry a lesser share of the risk on a deal. It reduces each persons exposure and downside should something go wrong.
Network:In the past we partnered with someone that had a gigantic network of high net worth individuals. This guy knows someone in just about any field and could get them on the phone pretty quickly.
Julie’s parents aren’t willing to take on partners, and they acknowledge that this has slowed down their wealth creation. They made the choice consciously but they’ve missed out on great deals because they weren’t willing to work with a partner on the deal.
On the other hand, we’ve expanded our wealth rapidly thanks to great partnerships but we’ve also experienced a lot more stress, surprises and drama than we would have without partners.
People like to make partnerships more complicated than they need to be. If you keep things simple it will be easier for everyone. There are also a few other things you can do to minimize the potential pitfalls of partnerships:
1. Before you get involved communicate a lot… and just when you think you’ve communicated too much … communicate some more! And a big part of communicating is listening. Listen carefully to your prospective partner. Ask questions. Understand their objectives and their needs. Make sure you’re going to be able to meet their needs. Focus on what you’re bringing to the table. Make sure it’s at least equal to what they are bringing to the table … preferably greater than what they are bringing to the table so they feel confident that they are getting a great deal.
2. Always be accountable.Recently we almost lost two really great rental property deals because our partner had less money to contribute than we had expected. We felt we had two choices … be bitter and lose the deals or be productive and save them. It literally took 100+ hours and it pretty much consumed our summer vacation but we saved the deals. And we are fixing the leaks in our process and learning from what went wrong.
We aren’t victims of anyone’s actions. And when you don’t accept the victim role you can keep control of the situation. And that is what we did. We accepted the fact that we had not done a good job of communicating, realized that we contributed to the disaster, and took the yucky tasting medicine.
If you are always accountable for what goes wrong in a partnership, you will be able to handle just about any of the pitfalls.
3. Have a clear and fair joint venture agreement created by a lawyer: And of course, follow up that accountability with a solid and fair joint venture agreement that lays everything out clearly for all parties involved. There’s nothing wrong with covering your butt!
Many of our readers, and yours truly, are constantly asking which is the better buy for an investor: single family homes (aka SFH) or multi-family homes (aka MFH)? Well, I am writing this to FINALLY put an end to the debate!
For the purposes of this article, we’ll consider either investment (SFH or MFH) to be a standard long-term buy and hold rental property (that means, not a reno, not a flip, not a Lease to Own, not wholesaling, short-selling, day-trading or any other real estate strategy out there!).
Now typically this discussion will take you down the road of buying Apartment Buildings versus Single Family Homes … but I am going to do this a little differently today. Sticking with where my experience has been which is in owning rental property varying in size from one unit to six units.
So for this article, a SFH is defined as a property (can be a detached house, condo, townhouse, rowhouse, etc.) that has only 1 unit and thus only 1 family living in it. A MFH, for the purposes of this article, is defined as any property that has more than 1 unit/family living in it. Thus, it could be a house with a basement suite (2 units), a duplex (2 units), a triplex (3 units), etc.
Advantages of Investing in Single Family Homes
Depending on the city/area, typically appreciate faster than MFH
Generally a broader range of potential buyers (when it’s time to sell)
Often worth more on a per unit basis (but this can be a disadvantage too as you pay more for it)
More liquid – SFH Can often sell quicker, even in a down market again due to a broader range of potential buyers
Only have to “deal” with 1 tenant, not many
Tenants don’t argue with other tenants because they are the only ones living there! There will be no issues around which tenant gets to use the bbq or front patio or even who puts out the garbage
Easier to get the tenants to pay for all of the utility bills again because they are the only ones using them
Some argue that you get a better “quality” of tenant in a SFH than in a multi-family, however, I do not necessarily agree with this. Will discuss why later.
The biggest disadvantage as an Investor is they rarely cashflow as well as a multi-family home
Can be “riskier” as there is only 1 tenant to pay the rent. If they vacate (and you can’t immediately place a new tenant), who pays the mortgage, bills, utilities, etc? You do! The MFH has more than 1 tenant so they at least continue to collect some rent to offset their costs.
Tend to have a smaller pool of renters because SFH tend to have higher rents than homes with multi-units. Thus, it may be more difficult to place a good tenant in a SFH because they tend to be more expensive.
No economies of scale with a SFH. If you or your PM are managing it, there is just the 1 house/unit/tenant. Most PM’s will offer discounts on a per unit basis if it’s a MFH, these discounts won’t apply on SFH. The same goes for doing repairs and maintenance, you may get a cheaper per unit rate if you are replacing all the windows or locks on a MFH than on, for example 3 SFH.
SFH are often slightly less conveniently located than MFH which again may hurt your chances to find tenants. Thus, SFH are usually slightly further away from main roads and public transportation, retail shops, offices, and other places that your tenant may want to be close to. This is because MFH are generally built in higher density areas. Higher density areas are built around shopping, stores, offices, etc.
Contrast these with the advantages and disadvantages of Multi-Family Homes as an Investment:
Advantages of Buying Multi-Family Homes
Potential to cashflow better because there are many more units purchased for a slightly lower price per unit – typically.
More than 1 rent to help cover your operating costs – if one unit is vacant there are other units bringing in revenue that will help you out.
Often a broader range of possible tenants to choose from as the per unit rental cost is usually less than a SFH
If 1 unit becomes vacant, you can work on it (paint, put in new floors, etc.) but still be collecting rent from your other units/tenants
Economies of scale: for instance, your PM will likely charge you less (as a percentage of the rent) on a 2 or 3 or more MFH than he/she will on a SFH. Furthermore, your utility costs will likely not be 3 times the amount (if it’s a 3 unit MFH) even though there are 3 tenants living there.
On a per unit basis are less expensive than SFH
Generally, your rent to price ratio is higher on MFH than on SFH (this can often equate to more cashflow)
Disadvantages of Buying Multi-Family Homes
Well, you can pretty much figure them out based on all of the above, but here’s a quick list anyways!
Maintenance tends to be higher as there often is more wear and tear because there can be more people living in the building, more appliances to service/replace, and often more tenant turnover.
Tenant placement costs tend to be higher as MFH’s often have more turnover than SFH. This is just my personal experience… I don’t have stats on this other than our own personal experience.
Tend to appreciate slightly slower than SFH
More limited buyer pool when it’s time to sell
May take a lot longer to sell because of the limited buyer pool
Two words: Tenant squabbles!
Financing can be more onerous.
From the advantages and disadvantages you can see there are plenty of reasons for and against both types so let’s give you a real life example of SFH vs. MFH and you can decide which is the better buy!
For this example, we are using 2 Single Family Homes purchased and compare them to 1 MFH (a side by side duplex). The reason we are comparing 2 SFH with 1 MFH is based on purchasing power. Basically, if you have X number of dollars to spend, you want to be able to compare based on that amount – rather than looking at for example $400,000 for a MFH vs. $300,000 for a SFH.
Here’s our real life case study on buying single family homes vs multifamily homes:
Bought 2 SFH properties: 1 – $74,500, rent was $720 per month 2 – $72,500, rent was $500 per month Total cost: $147,000, total rent was $1,220 per month Total expenses on these two was $1,200 per month Net cashflow of an exciting $20 per month!!
Today’s value: Total of $330,000 Total rent today: Total of $1,348 Total expenses: Total of $1,400 per month, currently a net loss of $52 per month
Bought 1 MFH (side by side Duplex) 1 – $152,900, rent was $1,600 per month Total expenses were $1,300 per month Net cashflow of $300 per month!!!
Today’s value: $350,000 Today’s rent: $2,450 Total expenses: $1,900 (after refinancing) Net cashflow of $550 per month!!
Which one do you think is the better investment?Well, in most cases I would think our savvy readers would think the MFH property is the better investment. And, for some of you it would be. There are a few reasons why I am not so sure the MFH is the clear winner. Let me explain why…
The 2 SFH’s are in a prime development area, thus the LAND value continues to go up and up and up! So, the opportunity for good appreciation is stronger in that area than where the MFH is located.
The 2 SFH’s are on freehold land vs. the MFH is in a strata community. Thus, there tend to be more restrictions on what you can and can’t do in a strata community than when you own the land on freehold title.
We have had a total of 4 different tenants across BOTH SFH’s in over 5 years! 1 of our tenants has not changed since we bought it and the other property has had 3 different families over 5 years. Meanwhile our MFH, while a pretty nice duplex, has had over 8 turnovers in the same timeframe. Higher turnover means higher placement costs, higher maintenance costs, and more stress!
So, the reason I share this example with you is to give you a taste that there often is NO CLEAR WINNER between SFH and MFH’s when it comes to real estate investing. What matters isn’t which is a better investment, it’s what is a better investment for YOUR time, energy and resources.
Before deciding multi family homes are the better investment because they have the potential for better cashflow, first ask yourself these questions:
Who will be responding to any potential tenant squabbles (me or a Professional Property Manager)?
Does the MFH have legal or illegal suites? If they’re illegal (which many are), just prepare yourself that if a noisy neighbour complains, that you may have to work with the City to either legalize the suite (can be costly) or decommission it. Either way, this may eat up a chunk of your time, energy, and money. So, be sure you don’t mind doing this.
Who’s going to be paying all the heat, hydro, and electricity bills? If each suite isn’t metered, you’ll want to determine if you can get your tenants to pay their portion or you’ll have to include it in the rent.
What about before deciding investing in single family homes is the way to go. Ask yourself:
Can I carry the costs (mortgage, electricity, taxes, insurance, etc.) when there are any vacancy’s?
Do I want to pay a Property Manager to manage just 1 tenant or can I handle the odd late night repair phone call and some minor maintenance issues?
Do I strive for more liquidity in my investments (the ability to sell faster)?
Do I want the potential for greater appreciation or just monthly cashflow?
By digging into what type of property suits you best is usually the best strategy you can have, rather than listening to all the “talkers” out there about which is the better investment. And yes, that even includes yours truly! So get out there and decide for yourself which is best….in all likelihood, whichever one you think fits your skills, personality, and aptitude, the better investment it will be for you. But, you’ll never know until you get started … so go ahead and get started!
Learn the secrets to becoming a millionaire real estate investor…in your spare time. Get the Rev N You with Real Estate Starter Tips Guide free when you sign up for our complimentary Rev N You with Real Estate e-zine.
Real Estate Millionaire students, we’ll call them Sherry and Curtis, are making great progress with the course. When we had a coaching call with them, they were all fired up to turn their home into a rental property and buy a new place with a basement suite. The strategy (turning your home into a rental property when you move to a new place) can often be a very good one.
We were excited for them, but when we spoke to them, we were a little concerned that they were getting too emotional about things. Sherry was afraid of turning her home into a rental property. She had put a lot of time and effort into creating a beautiful and comfortable home over the years and was really worried it would deteriorate without her. Who will water the flowers she asked? Curtis was excited to get into the real estate investing game and couldn’t wait to move into a home with a yard.
They were planning to meet with a realtor the next day to get an idea of what their current home was worth, and then they were going to look at some listed properties in the potential new area on the weekend.
When we hung up the phone with them we sent a follow up email with some pieces of advice … the biggest point from Julie was:
“Take a deep breath – I sense a lot of emotions (fear, excitement, nervousness) and that is NOT GOOD. Emotions are bad when it comes to investments. DO NOT LIST YOUR HOUSE IN A PANIC. DO NOT BUY A NEW HOUSE BECAUSE IT LOOKS GOOD. DO NOT DO ANYTHING THIS WEEKEND. Give yourselves time to think in a relaxed state. There is no urgency to your situation and that gives you power (and control). You always want to have power when it comes to real estate.”
That was Friday. Sunday morning we received an email saying “Don’t be mad, but we just put in an offer on a house“.
We are not about to get mad. We want our students to take action – and there is NOTHING WRONG WITH MAKING OFFERS. And, as long as you make them “subject to” an inspection or financing, it gives yourself a way to back out if your research turns up areas of concern. However, when you do make an offer, especially in this buyer’s market, make sure you keep control of the situation.
In our students case, we think they lost control for the following reasons:
They’d only looked at a handful of homes in this area (which is pretty light market research),
They were still very emotional about everything,
The realtor had only given them 4 business days to remove their subject to inspection clause,
Closing was only 30 days later (when they’d specficially stated they needed time to sort out whether they were in fact going to turn their home into a rental or sell it),
And, the realtor coached them to go in with a strong price to show they were serious. They only offered about 4% less than asking!
The good news was that the realtor had been unable to present the offer to the sellers, so there was still time to change the offer. We suggested that they contact their realtor and find out why, in a buyers market without competing bids on this property, she was pushing them to be so aggressive. And, we also suggested STRONGLY that they change their offer before it was presented so that they had a lot more time to conduct their due dilligence and ensure they were comfortable with their decisions (of buying, of renting or selling their place, etc.).
They ended up pulling their offer … and guess what … 3 weeks later the house is still on the market. If they want to, they can now go back in, more relaxed, offer a lower price, give themselves more time for the details, and get a much better deal. But that is because they’ve now had 3 weeks to slow down, take the emotion out, revisit their goals, and look at more properties. They still like this one … but they know that there are other potential deals out there now too.
The 3 Biggest Lessons to Learn from their experience are:
SHOP AROUND! Be patient as you look for the deal that is right for you. When you find the perfect place – act quickly and decisively, but be sure it’s the right deal. This house may be a great deal but the only way they can know that with certainty is to look at a lot of other houses in that area. This means looking at 20 – 50+ online listings, viewing dozens of houses through open houses or appointments, and becoming an area expert.
Always remember the motivations behind the people you’re working with. NOBODY will love your money as much as you do. Realtors get paid when the deal is done. That doesn’t make them bad people but it does mean that some realtors will push for terms and conditions that get the deal done … not necessarily that get YOU the absolute best deal for you. Great realtors know the market inside and out, understand deal making, and are able to work hard to find you the deals that meet your goals. Not every realtor is created equal. There’s nothing wrong with parting ways with your realtor if it’s not working out – just be honest and up front about it.
You must take fear, excitement and any other emotion out of the equation. If you are emotional then you will not make good decisions. Things can go wrong, and little things probably will go wrong. That is just life … if you’ve been following our renovation adventures on our blog, we’ve had plenty of little set backs. It’s cost us more money than we expected and added a week to the project but we never once thought “we never should have done this”. Think about what could wrong, and then think about what you would do if that actually happens. Write it down so that you can actually see your fears in front of you. Most of the time the fear is irrational, unlikely or manageable. (That said, next week we’ll share a response we had to a reader about the risks in real estate, and when to know when the risk is too great to proceed). If you are too excited, then just take a step back. Don’t do anything for 24 hours and then see how you feel.
We’re really proud of Sherry and Curtis – they are making fabulous progress towards their goals. And they are incredibly smart and hard working people. They are taking time to educate themselves and they are reaching out for help to avoid the pitfalls that often trap new investors. They will be successful in their real estate ventures and in their life.
We don’t think they were making a life destroying mistake with the deal they were creating, but we do believe that they weren’t getting the best deal they could– especially in the buyer’s market we’re in right now. We knew they were emotional about the whole thing, so we know they didn’t think it through. It can happen to ALL OF US (believe us, we know)!
Some Words of Wisdom:
“Those who have never made a mistake are doomed to work for those who have.” – unknown
“The reason you are in negotiations are to do better than your alternatives.” –Keith J. Cunningham
“Aim for success, not perfection. Never give up your right to be wrong, because then you will lose the ability to learn new things and move forward with your life.” – Dr. David M. Burns
“Have a bias toward action — let’s see something happen now. You can break that big plan into small steps and take the first step right away.” – Indira Gandhi
If I asked you to describe your perfect real estate deal to me, would you be able to give me five things that HAD to be in the deal to make it “ideal”?
If I asked you the same question about your perfect real estate agent or mortgage broker or investment partner, would you be able to give me the 5 most important qualities of each off the top of your head?
When Michael Losier, author of Law of Attraction, asked me to describe my perfect joint venture partner, I froze! Um, ah – “I want him to have money”.
Michael said, “Well, I have lots of money. That doesn’t mean I am going to invest it with you.”
Ouch! But, his point was well taken. I wasn’t clear. And, I am pretty sure this lack of clarity has been holding me back! How do I know what I am looking for if I can’t clearly describe my ideal joint venture partner? The same goes for a deal, a realtor, a mortgage broker, a lawyer and so on!
You see, many things are important to your success as a real estate investor. Taking the time to complete good market research, carrying out careful due diligence, and using a little creativity are all important. Some things are helpful but you can work around them like good credit or cash in the bank. And, other things, may not be necessary at all when you first start out like finding a high powered courtroom attorney and a full time book keeper. But the one thing that you do need is an idea of what you’re doing and why.
We’ve always said that you start with your goals. Figure out where you want to go, then make a plan to take you from where you are today, to where you want to be. We’ve said it’s the one thing you must do in order to overcome emotions in real estate investing and it’s always the first step in our real estate investing process. But, as we sat down with Michael Losier, author of Law of Attraction it became obvious that we hadn’t taken this step quite far enough yet.
And the most beautiful part of this whole story is that it only took Michael about 5 minutes to help all of us on the call describe our perfect joint venture partner. This one single tool (and he gave us many tools on the call to use in our lives and our investing business) has already changed my real estate investing life.
He told us to:
1. Take out a piece of paper and draw a line down the middle to create two columns.
2. At the top of the left hand column write CONTRAST. At the top of the right hand column write CLARITY.
3. Beside CONTRAST write negative.
4. Now, in the column of CONTRAST write down everything you DO NOT like or DO NOT want in a joint venture partner.
Suddenly – I had a long list. I don’t like partners that don’t call me back, that never have money, that are too controlling … I could go on and on. It was really easy to describe everything I didn’t like or didn’t want in a partner.
Next, Michael said, “So, what DO you want?” You don’t want a partner that never calls you back, so you want a partner that is “Responsive and easy to get in touch with”. You don’t want a partner that never has any money, you want a partner with “lots of investment money they will use for your investments”. And we went down the list … and every time we created the specific detail about what we DID WANT, we crossed out the corresponding negative item. (You can download a copy of my Contrast/Clarity Example Here)
It felt great! I had clarity. And, I felt good about it. No wonder Oprah loves this man!
I’m now sitting down to create a contrast and clarity sheet for every aspect of our real estate investing business. I know that I will find better partners, better deals, and better team members in the future because I will know exactly what I am looking for and what is ideal!
He has a $99/year program where you can get on the phone LIVE with him for 60 minutes every month. He also has a new book coming out in June – all about improving the connections in your lives. As real estate investors, our entire world is about connections so we’ve already preordered it!
Oh, and if you want to listen to the call to learn all the tools and read the transcript, you can order a copy here. But you’ll want to do so soon as we’re only selling it until May 21st!
Being a rental property owner means dealing with maintenance, repairs and tenant upgrade requests. Even if you’ve hired a property manager, you will still have decisions to make regarding the upkeep of your property.
In general, you should set a maintenance schedule that keeps your property and the unit(s) in your property in the best shape possible. There are several reasons for doing this, but the biggest one is that a property that is kept in good condition attracts and keeps good tenants. The second big reason for doing this is that regular maintenance is often a good way to keep costs down. If you leave things unfixed for long periods of time it can cause other issues. For example, a leaky sink left unfixed could be damaging the cupboards and even the floor underneath the sink.
If you have a property manager ask about their schedule for doing the following things. If you manager your own property, then here’s a suggested schedule for checking on things.
Monthly: Walk the exterior of the property and pick up garbage from around the property. Make sure the lawn is mowed, weeds are pulled and everything is in good shape. If you have laundry facilities, check that the lint is being removed from the dryers and take out any money if they are coin operated.
Quarterly: Check windows, doors, and exterior of the house for any leaks or damage. It’s also a good time to check on the furnace or air conditioner and change filters.
Semi-annually: Change the batteries in the smoke detectors, check carbon monoxide detectors, clean gutters, check appliances, plumbing and electrical outlets in the house. Check for things that might be loose as well (door knobs, railings, or screws). You aren’t looking for things to fix but you want to be aware of things that may require maintenance when a tenant moves out or trying to find little things to repair cheaply as a way to prevent bigger problems later on.
When tenants move out: Have the carpets and drapery cleaned. Paint the walls if necessary (and usually it is), and get the unit professionally cleaned (including the stove and fridge).
Planning for this regular maintenance on your rental property makes things fairly easy. You will have a good idea of when major expenses like a new roof, a dishwasher or a paint job will be required. You can set aside a little extra rent money to cover these costs. The trickier part can be knowing when to make improvements to a rental property when a tenant is asking you to spend money.
In our Toronto tri-plex we recently turned down our tenant’s request for blinds in the living room of one unit. But at the same time, we agreed to put in a new toilet in another unit. Our tenants can easily figure out that we’re bringing in nearly $4,000 in rent per month from this property, so they may think we’re being stingy by refusing their requests. But, you have to keep in mind that, while you want to keep your tenants happy the money your spending needs to either prevent or reduce an expense or it needs to generate revenue.
In the case of a renovation or upgrade requested by a tenant, we ask ourselves a few questions when we’re considering whether to do the work the tenant is asking for:
What are the costs of not doing it (is the tenant likely to leave and what will that cost if they do?)?
Is there another way to address the problem?
Are there any issues with delaying the expenditure?
After we consider these things, we use a final formula to calculate how long it will take to recover our costs.
Total Cost of the Upgrade or Repair / New Money Earned (or Money Saved) each Month = # of months to repay the expense.
On items under $1,000, as a general rule of thumb, if you can recover the cost in 12 to 18 months then the money is well spent.
In the case of the blinds, the tenants wouldn’t pay more rent just to have blinds. Instead we agreed to pay for dry cleaning the curtains which will be less than $100. There’s no direct return on this – but the tenants wanted the “dirty curtains” replaced so this will keep them happy and it’s not a large expense – especially given that the tenants have been long term.
For the toilet replacement request, we decided that getting rid of the grungy old toilet will not get us higher rent, but it will make it easier to attract and keep good tenants. And, if we replace it now, our tenant’s father (an experienced plumber) will install it for free. Finally, we’re replacing a water guzzler with a low flush model (est. water savings of $10/month) that will qualify for a $75 water conservation rebate from the City of Toronto. The formula of benefits looks like this:
$250 – $75 rebate = $175 Cost of the Toilet
$175 / $10/month water savings = 17 months to pay off (PLUS we save $80 on installation).
The cost savings plus the added benefits of saving installation costs made it a very appealing use of our cash. Just remember – real estate investing is a business and you need to get a return on any money you spent – even if that return is simply in cost savings!
If you are managing a property yourself there’s some great books out there to help you. Two books definitely worth checking out are:
I know that’s a lot of information to digest and a substantial list of resources, but your monthly cash flow is dependent on you maximizing your rental revenue and minimizing your expenses – so this is pretty important stuff to know!
Susan* and her two partners hit the streets in Toronto earlier in 2007 to find a payday by flipping real estate. Their mission: to find a really beat up house in an up and coming Toronto neighbourhood, fix it up and sell it within 5 months.
The three of them wanted to gut the property and renovate just about everything in the house. They expected to do all the big jobs from ripping out walls, redoing the plumbing and wiring, to putting on the finishing touches! Unfortunately, Susan tells us the “planning” was A LOT easier than the “doing”.
Flipping Real Estate Sounds Easier Than It Is
This wasn’t their first reno project. Susan and her two partners had undertook a smaller project in early ’06. With that experience under their belt, they decided to take it up a notch with this project. The house they found was in need of a large scale renovation. They purchased it using some cash and an Open Variable 5 year mortgage (the rate and payment floats with the Prime rate and there is no penalty for paying the mortgage out within the 5 year term). They anticipated it would take approximately 4 months to complete the work and a few weeks on the market to sell – it was going to be a masterpiece!
Well Murphy’s Law was busy during this project. The basement flooded due to shoddy, unlicensed “plumbers” cutting the water main line inside the house. The dumpster bin outside the house was being filled by neighbours while the walls were ripped out over a painfully slow 3 weeks (and the neighbours didn’t help pay for the extra costs of the garbage). And the best part, during the delays and stress, the workers were playing the partners against each other! One would say “Jack said it was okay that we do this with the wiring”, while Susan was trying to say “this is not how we agreed to do this”! And when they finally were done most of the work, and were almost 2 months past their planned completion date, the building inspector went on vacation leaving them to wait a couple of more weeks for his return.
Six months after they started work on the house, they were finally ready to sell the property. But, thanks to delays, the sale landed smack in the middle of summer which is just about the worst time to try and sell a house. Every day the house remained unsold meant additional carrying costs (financing, hydro, heat, taxes, insurance, etc.), so waiting for the fall market to hit was financially not an option. As for the neighbour who agreed to split the cost of a beautiful new fence that separated the two properties? Let’s just say Susan and her partners are still trying to recoup the neighbours half of the fence. Unfortunately, our “word” no longer is good enough. Get it in writing folks!
It was stressful, time intensive and a lot of work. So, why bother with doing a flip? Well, Susan says they did make a decent profit (about a 10% return on investment in about 8 months). And, she enjoyed the opportunity to be creative and handy! Susan said she loves interior decorating and seeing the fruits of her labour. Turning an ugly duckling into a shimmering Swan is a thing of beauty. It also gave her ideas as to what she would like to do with her own home. And, for those who like shopping – be it for doors, windows, faucets, door knobs or curtains – it’s a great excuse to check out all the latest trends at Home Depot, Ikea, or Rona!
Susan gave us 4 Do’s and Don’ts of Flipping Real Estate:
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Have a detailed, set budget with a healthy contingency;
Get 3 or more quotes on all jobs;
Get permits for all work to be completed; and
Have a detailed partnership agreement from the beginning.
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Don’t sell in the Summer or launch on a long weekend;
Never assume that a carpenter can do drywall taping or plumbing;
Do not let the trades people pit the owners against one another; and
Don’t get greedy when selling…often the first offer is the best!
It wasn’t a bomb, but it was a bigger challenge with a lower pay out than she expected. Will Susan complete another Flip project?
She has every intention to, although it may be a few months or a year until she is ready to jump back into it. Besides her great advice above, she said it is very, VERY important to hire the right people. Just because General Contractor X is cheaper than General Contractor Y doesn’t mean you will profit more in the end because you “saved” some cash. The old phrase exists for the housing industry just like anywhere else – you get what you pay for!
9 Tips for Success with Flipping Real Estate
by Julie Broad
If we are going to go to all the work to renovate a place, we want to reap the benefits for years to come. When we renovate we do it with renters in mind, not future home owners. But, if we were going to pursue a hobby or business in flipping here are some things we would consider when looking at a house:
My requirement for a home to live in, and a good rental property would probably hold true in this case too: Find the Starbucks area
Find the ugly house on a street of well maintained homes.
Know your prospective buyer – are you fixing the house up to suit a young family, an urban couple, or someone whose kids have left the nest? Figure out who is most likely to move into that area, and renovate to suit their needs.
Where is your biggest place to add value? If you can easily enlarge the kitchen or make it more functional then you can add a lot of value to the home quickly. You can also consider adding a bathroom or creating more storage as ways to add value.
Inspect the house carefully. Have there been renovations done on the property? You will often pay a premium for previous renovations, and in so many cases you will end up having to redo what was done before so it costs you more for the house, and to do the work.
Determine your budget, and then add an additional 30 – 40%. Things always cost more and take longer than you expect.
Find a real estate agent that has flipped houses themselves, or that has a few clients that have done it. And, ask for references. A good agent will go a long way to helping you understand the needs of your prospective buyers, and in getting the price you want for your house.
Talk to a mortgage broker about your financing options. There are plenty of financing options to suit a flipper purchase.
*Not her real name. She has asked to remain anonymous, but will answer questions through us if you are interested in learning more.
When you first start shopping for a property manager you might be shocked to learn what many of them charge. We certainly were!
You’ll usually pay between 5 – 10% of your monthly rental income to a property manager plus tenant placement fees which can be as much as one months rent. The price may seem astronomical at first. It certainly eats into your positive cash flow!
When you learn the cost, the desire to manage the property yourself and save money will be powerful. Saving a few hundred dollars each month may not be worth taking on the property management yourself though! Besides the fact that a professional property manager has extensive knowledge of the local laws and regulations, they also have access to the resources required to easily manage a property.
When we first bought our Toronto tri-plex, Julie was doing her MBA and thought she could handle managing the property while she was in school (Julie is shown in the picture above painting that Toronto Tri-plex – you can tell she is loving it!). We wanted to save money, and Julie had a flexible schedule with some free time so it seemed perfect.
We went to the property and met with each tenant, introduced ourselves and made sure we had the proper signed leases in place. After that, we both figured Julie would only have to deal with minor issues as long as the property was occupied.
We were wrong! The tenant on the main floor proved to be high maintenance and called weekly about different things she wanted fixed. And then, two months into owning the property, the frequency of calls from the tenant on the main floor began to increase dramatically. She was upset because as the weather got colder, the tenant beneath her was smoking in the unit and she could smell it. Her son had asthma and this was impacting him.
Julie contacted the tenants in the basement and explained that their lease stated that there was to be no smoking in the unit and that we’d received complaints. They were polite to Julie. However, they didn’t like getting scolded and – according to the main floor tenant – started taunting her teenage son when he would come home from school. They called him a tattle tale and made him feel threatened.
It’s a long story. It dragged out for weeks, but the issues escalated. Soon the two tenants were at war and Julie was receiving 20–25 calls a day. The police were called to the scene twice by the tenants on the main floor. It was a disaster.
And as luck would have it, this was happening during Julie’s final exams! Julie was pretty close to breaking down and couldn’t just tell the tenants to wait a week until her tests were done–she had to deal with it!
Julie pretty much lost it. She’s really a no nonsense kind of person and she hated dealing with other people’s problems. Failing an exam would mean she’d have to repeat a course and that could mean an extension of her degree–which would be time consuming and expensive.
She was fit to be fried. And looking back, it should have been obvious to both of us that Julie was not well suited for the job. She is organized, efficient and focused. Sounds perfect for property management doesn’t it? Well, not exactly. Anything that throws her off what she is working on at the present moment is an annoyance for her. She also doesn’t like talking on the phone. She’d prefer never to pick up the phone at all if she could avoid it. She likes people and she likes problem solving, but she doesn’t really tolerate people who are lazy or rude. Really, she has a lot of traits that make her well suited to HIRE a property manager!
To tell if you could handle the pressures and challenges of property management you’ll want to do a little bit of a self assessment. We’ve created 8 simple questions to ask yourself to see if you think you could handle property management.
Are you a reasonably tolerant person? Be honest with yourself.
Do you have any knowledge and experience with doing minor maintenance and repairs?
Are you able to sell and negotiate? You will have to sell the unit to renters, you’ll have to sell the idea of paying rent on time, and you will have to have the problem solving and negotiation skills of a salesperson in order to handle some of the issues that will arise.
Can you visit the property on a regular basis? You should stop by at least monthly so make sure it’s convenient and possible to do so. Plus, if you do get a 3am call that requires you get there right away, are you going to be able to?
Are you comfortable and capable of keeping good records? We’re a little weak at this ourselves, and we likely miss out on tax write offs because of it. It also takes us several days to prepare our books to send to our accountants each year because we aren’t as organized with our unmanaged properties as we should be.
Are you able to diffuse angry individuals and ease any tensions between them? How do you handle difficult people? When dealing with a difficult person do you get angry and frustrated yourself?
Imagine the busiest possible day, and then imagine having to handle a call from one of your tenants about a frozen pipe or a broken door lock. Are you going to be able to handle that situation?
Do you have someone that can be your back up if you take a vacation or go out of town? If there’s an emergency at your property, your tenants need to be able to get in touch with someone that can make decisions about the property.
If you answer “no” or “I don’t know” to three or more of these questions then you should seriously consider hiring help. Property management is a job that requires expertise, skills and resources. It’s possible to do it part time while working a full time job, but there will be days where it’s not easy.
These questions are not exhaustive. There are other things to consider when you make the decision whether to hire a professional or not, but spending a bit of time honestly answering these questions will really help you figure out if you want to be your own property manager. You may find the cost of a professional is worth every penny.
I have to give credit to Julie for this little tip. This is her creation. Somewhere along the line she just started doing this to simplify and speed up the process of evaluating properties for their cashflow potential. As she confessed last month, she doesn’t like numbers and math to evaluate properties. And, this technique is one simple calculation that tells her to continue looking at a property or to move on. While I spend hours pouring over spreadsheets and killing the battery on my calculator to assess the cashflow of a property, Julie can make her decision whether to investigate a property further in 60 seconds.
Julie calls it the 1% Rule
All you need are two numbers: the price of the property and the rental income you will get each month. If the monthly income is 1% of the purchase price then you are pretty much guaranteed a property that will cashflow.
For example, if you have a property that costs $300,000 and it gets $3,000 per month in rent, Julie’s simple calculation tells her that it is a property she’d like to learn more about. The numbers are looking really good.
If you have a property that costs $300,000 and the rent is $2,100 per month, it’s hitting .7%. She’d probably still look into this property, but she’d do it knowing that the money will be tight. Anything lower than than .7% is going to be really hard to make cashflow without either a big downpayment, lower purchase price or higher rent.
The 1% Rule in Action – Making Sure Properties in a Specific Area have the potential of producing positive cashflow:
We’re looking at areas in Canada and the U.S. where we will record our upcoming video series. In the video series we’re going to follow our real estate investing process from start to finish to buy a property. One of the places I have been researching is Austin, Texas.
Let me show you how I’m using Julie’s 1% Rule in the evaluation of properties in Austin:
I did a search on Realtor.com, and I found 10 single family homes in the St. Edwards area, ranging in Asking Price from $289,900 to $299,900 (because I limited my search to a max. of $300,000).
Multiply .01 (1%) by $290,000 and you get $2,900. If you can get around $2,900 rent (per month) in that area on a house that costs approx. $290,000, then you can be very comfortable that you will have a strong positive cashflowing property.
You can even drop the 1% to 0.8%, and you will still likely have a positive cashflow property. Why not just use 0.8%, you ask? 1% is just a rule of thumb. Basically anything over .7% is worth looking into further. But, you can decide the exact number you’re looking for based on your objectives, the strength of the area, the size of the down payment you have and the cost of financing you can obtain.
If you can put down 25%, you can decrease the 1% rule to 0.8% or possibly even 0.7%. However, if you can only put down 10% and the bank is going to charge you 7% interest rate, you will want to achieve closer to the 1% rule.
Let’s look at the 1% Rule decreased to .8%. Let’s say you have a 25% down payment for this example:
If you have 25% to put down and are going to use the 0.8% rule, that would be .008 x $290,000 = $2,320.
You want to have approximately 35% of your rental income available for expenses (management, insurance, property taxes, maintenance, etc.). So, if you can achieve $2,320 in monthly rent, subtract 35% for expenses, and that leaves you with $1,508 ($2,320 x .65) available for your mortgage costs.
$1,508 in a monthly mortgage payment at 5.5% interest rate, with a 30 year amortization can afford a $267,420 mortgage. In other words with a big down payment and the low interest rates available in today’s market, the .8% rule will work. If you bought the $290,000 home with only 10% down, this would leave you needing only a $261,000 mortgage ($290,000 x .90 = $261,000) yet the $1,508 monthly payment can actually pay for $267,420!
But, Julie complains that she can’t do the math in her head on .8%, so she sticks with 1% and just knows that a little bit lower than that will still work.
It’s just a simple rule of thumb for quick and easy assessments. Once you’ve found properties that have potential for cashflowing, you still have a lot of work to do to make sure the property is a good one to buy. At least using this trick you can feel comfortable that you will be spending the time learning more about a property that has good potential.
In the game MONOPOLY, “Money can be loaned to a player only by the Bank and then only by mortgaging a property. No player may borrow from or lend money to another player… In life away from the game, getting a mortgage can be a complicated, tedious, nail-biting and hair-pulling ordeal. In MONOPOLY, it’s quite simple. Unimproved properties can be mortgaged at any time. No haggling or negotiation is necessary – or, for that matter, allowed. The ‘Mortgage Value’ is printed right on the property deed.”
– Alan Axelrod, Everything I Know About Business I Learned from MONOPOLY
In less than two weeks, I will be over at Julie’s parents home on Salt Spring Island to celebrate Christmas. I fully expect that we will play at least one game of MONOPOLY. It’s not just family fun for the Broad’s though. Her parents have been investing in commercial and multi-residential real estate for over 25 years. It’s never a relaxing game. Everyone is out to win. It’s not just about pride … it’s about proving your real estate investing prowess, or at least it feels like it!!
The reality is that MONOPOLY is much simpler than real life. Thankfully, unlike in MONOPOLY, there is more than one way to finance a property. You can ask your father-in-law or you can get a first and second mortgage. You can assume someone else’s mortgage or get financing from the vendor.
And best of all in real life, you can get a mortgage broker working for you, and they will handle the time consuming part of shopping the mortgage around and coming up with the best options given your personal situation. It’s not to say that you can’t get a good deal if you go directly to your bank, but what we’ve found is that banks have a well defined box that they want everyone to fit in, and as a real estate investor, you probably aren’t going to fit nice and neatly into that box. Maybe on property #1 you will, but pretty soon you won’t. And, a mortgage broker that works with real estate investors will know who to talk to and where to find the type of mortgage product you need. (In October we did a five part interview with our mortgage broker which you can check out on our website…we covered everything from buying a property in a corporation to Americans buying in Canada and Canadians buying in the U.S.).
What financing options are available to you?
Hopefully after last week, where I discussed down payments for your real estate investments, you understand that I am not going to teach you how to do “no money down” or 100% financed deals. They are so risky and stressful that it’s just not the way we would recommend you get into real estate. So, I am not going to specifically address the questions our readers have sent in about getting 100% financing.
“Where to start? What’s the best way to finance?” – reader from Loveland, COInstead, I am going to focus on the many questions that revolved around just understanding the basics around financing property purchases:
“How to talk to mortgage guys to come up with creative ways to do deals.” – reader from Johns Creek, GA
“How do you get a hold of the necessary funds to fund a deal/property with the market as it is right now.” – a reader from Tempe, Az
First, let me say that the banks ARE still loaning money. The tap has not turned off, so don’t throw your hands up and say “I’ll never get a loan”. That said, it is a bit more difficult, but with interest rates at historic lows, it’s a pretty darn good time to at least give it a try. And if you aren’t successful with the bank, know that there are private money lenders, sellers willing to finance and a few other options. If you don’t like these alternative options as much, you can always use one of them for financing for a year or two, and then try the bank again once the smoke has cleared from the current financial crisis.
So, let me take you through the essential things you need to know before you set out to fund your investments.
The Most Common Sources of Financing Real Estate Deals:
Banks:Well, actually, I should call these traditional lenders because it does include credit unions and trust companies, but mostly you’ll think of banks when you think of a traditional lender. This is typically your cheapest source of funds, but they have very rigid rules about what qualifies for a loan from them.
Sellers:Also called Vendor Take Back Financing or VTB’s, seller financing is basically when the seller of a property will essentially leave some of their equity in their property (instead of taking cash for it) and the buyer will borrow it from the seller and make monthly payments towards paying it down. You can typically expect to pay the seller a slightly higher rate than you’d pay a traditional lender, but many sellers are willing to do this because they get a guaranteed return on their money and their money is secured against the property. It’s also the only way certain properties will sell. If the buyer doesn’t make payments, the seller can often just take back the property. However, this only works when the seller has quite a bit of equity in the property or owns the property completely.
Secondary Lenders:Companies that provide higher interest rate loans to candidates that do not fit into the traditional bank boxes.
Equity Lenders:More common in commercial real estate than in residential real estate investing, but it’s essentially a company that will loan money based on the value of the property alone. They usually will loan up to 60% of the property value no matter who is the borrower.
Private Lenders:When you think of private money you might think of the mob or someone backed up by a tough guy with a baseball bat. Maybe that is because they are also called “hard money lenders”, but the reality is that it’s anybody or any company that has money in a fund that they will loan to an investor. You can expect to pay a higher interest rate and often a fee for their loan, but there are many options in private money.
With the exception of Equity Lenders and possibly sellers (VTB’s), every other lender on the list will pull your personal credit score, so make sure you know your credit score and are working on increasing it.
For us, we typically try for seller financing on every deal. We have often been able to get the seller to take a second position (which means they will provide a small portion of the financing and will sit second on the mortgage behind the bank). We’ve only been able to get complete seller financing once. Usually the vendor wants their cash out for a different purchase or they just don’t have enough equity in the property.
When properties aren’t selling, which is the case in many areas in North America right now, motivated sellers who have 50% or more equity in their properties will be more likely to hold a short term VTB just to sell their property…so you should always ask!
You will find that every deal is different. Our first two deals were financed by banks with 10% down and 5% down respectively. Our third deal we assumed the mortgage from the seller and got a small loan from our real estate agent that was secured against the property.
We’ve done seller financing on several deals, but to be totally open with you, most of our investments have been purchased using our mortgage broker who shops us to every traditional lender she knows, and finds us pretty darn good rates with lenders who are willing to get creative!
Next week, as we roll into part 4 of our “Rev N You Readers Biggest Real Estate Investing Questions” series, we are going to answer the biggest question we get asked at social gatherings: “Is now a good time to buy?”. The answer might surprise you. Sign up for our Rev N You with real estate newsletterto make sure you get the article!
You probably won’t like what I have to say this week. But, the brutal reality is that you can’t spend everything you make and expect to get rich. Period. If you are slipping further and further into debt each month and you think real estate investing is going to save you, I have bad news for you. It won’t.
I know… those guys on late night television introduced you to people who got out of debt and quit their jobs just 60 days after taking their real estate investing course. Let me tell you first hand that if those testimonials on t.v. are even real, those people are the exception, not the rule.
You can, and we believe you WILL, create massive amounts of wealth through real estate investing. Set your goals, find properties that meet those goals with plenty of good research and then hold onto them for at least five years…preferably longer. It works… look at the richest people in your city. Of those that are self-made, I bet at least 25% of them did it through real estate. We always go through the richest people in Canada, and Power List for Vancouver, and this number holds up.
The trick is to learn what you’re doing, and then accelerate your investments after you have built a base of knowledge and equity. It’s not the only way to make millions in real estate…but it’s the way that requires less money, has the least amount of risk, and induces the least amount of panic attacks.
“Are you a saver or a spender? As I see it, the wealth seeking world is divided into two camps. In one, you have the wealth accumulators: men and women who are cautious about spending but eager to save and invest. The other camp is populated with spenders: men and women who are obsessed with things. They spend all their spare money, and often much more than that, buying things that say “rich” but actually impoverish them. To become wealthy, first you need to build a small nest egg by spending less than you earn. Simple, huh? But not if you don’t have the self-discipline to do it.”
We started out with $16,000. Thankfully Julie was a saver. When she graduated from University and started working as a sales rep she continued to live like a student. And, she put every extra penny she had into paying down her student loan. When that was paid off, she proceeded to save the extra money. Her plan was to go back to school for her MBA so she wanted to have as much cash in the bank as possible to pay for school.
When we met, I had a property with my Mom that we’d purchased years before, but didn’t have much else. After years and years of being a student, I wanted to enjoy the money I was making. I drove a nice new financed Volkswagen and enjoyed my nights out in Victoria. I didn’t spend money excessively, but I was carrying credit card debt and didn’t have savings. Julie shared her visions of “retirement at 35” with me, and I got excited.
It didn’t happen overnight, but it only took a few months to change my situation. I quickly paid off my credit card debt, and started putting a few hundread dollars away each month in savings. And, we started shopping for our first investment property.
Our first investment was a lot easier to do thanks to Julie’s school savings. But, you don’t need money to buy your first property.
I will get into the details in a bit, but as far as we’re concerned, there are only 3 ways you should consider coming up with a down payment on a property, but the good news is that only one of them requires that you have money saved:
1. Your own savings (cash out stocks, GIC’s, and even retirement savings in some cases)
2. Equity in your home
3. A partner with cash.
Here’s the hard reality that you won’t like to hear though. Finding a partner will be next to impossible if your own finances are ugly. If you have no experience investing in real estate, you are deep in debt and you are trying to get rich on my money, what exactly is in it for me, as your potential partner? It just sounds risky to me.
But, if you come to me and say “Dave, I have found this property that I think is a great investment. I don’t have any money because when I graduated from University two years ago, I had $30,000 in student loans. I only have $5,000 left to pay off, but I really want to get started real estate investing and I think this deal will be great,” I will be more interested in working with you.
See what I am saying? This person has no money, but they have the right mindset about money. They are in debt for a good reason AND have been diligent about debt repayment.
You HAVE to get control over your finances before you buy a real estate property. Even if you have nothing for a down payment. You need to change your lifestyle so you are living beneath your means. From now until the end of January track every single penny you spend. Then see how that compares to the money you made in the same time frame. If you spend more than you make, you need to make changes!
Oh – I hear it already – but, Dave, it’s Christmas! I have to get the Wii Fit for my wife, and the kids will hate me forever if they don’t each get an IPhone. Well, if you’ve saved up for those gifts, great! Go for it! But, if you are going to go into debt for those gifts then you are a SPENDER, not a SAVER and you’re obviously not serious enough about growing your wealth and becoming a rich real estate investor.
So, in answer to the questions about money and down payments, like these ones:
“Should I approach other investors for partnering when I have no money for startup? I feel like I will be swallowed by sharks even though they all seem nice enough. I have seen several nice properties (4 plex on up) but I need to make the big leap to action.” –a reader from Portland, ME
“Now that my credit is “good”, coupled with the changing real estate landscape, how much upfront capital is needed?” –a reader from Matthews, NC
“I hear a lot about using credit card, home equity line, owner financing for down payment. What is a realistic timeline to see a positive r.o.i. to reimburse funds?” –a reader from Cleveland, OH
“How can I do deals like Robert Allen – no money down, cash back on closing” –a reader from Hamilton, ON.
the general answer I have is for you to track your spending, and make sure you spend less than you make, each and every month. Then, use the excess to pay down your debt or save for your real estate investments.
PLEASE PLEASE PLEASE DO NOT USE YOUR CREDIT CARD TO FINANCE YOUR REAL ESTATE INVESTMENTS!! Just the other day Julie reminded me of one of the first things we did at a “Get Rich Quick” real estate course we took in Toronto many years ago. During our break the real estate guru told us to call our credit card company and get our credit card limit raised and a percentage knocked off the interest rate!
The room was buzzing with excitement after the break. Everyone proudly told stories of getting credit of $5,000, $10,000 and even $20,000 added to the limits on their cards! And some even excitedly reported that they now would only be paying 18% interest instead of 21%.
What if something goes wrong with your investment and you end up paying that 18% interest on that $20,000 for years to come? Do you want me to do the math on that?
As for the other methods our newsletter readers asked us about…using home equity and vendor take back financing, it really depends on your goals and where you are right now in your life. If you’re 65 and getting ready to retire, I am not sure I would use the equity in your home. But if you are under 50, and have $200,000 equity in your home, I would definitely consider a $50,000 home equity loan for a down payment on a real estate investment – assuming you can cover the extra payments if something goes wrong with your investment.
On a good deal, your rental income should pay for the monthly payment increase that the additional $50,000 home equity loan will cost you, along with all of the other expenses on the rental property. In this case, I think that it’s a great source of money to use for a down payment on your first property.
As for owner financing. I love using owner financing. We’ve used it several times when we don’t quite have enough for 25% down and the bank won’t lend us any more than 75% on the property. Sellers are often happy to oblige with a loan for the difference. It’s secured against the property, it gives them a nice guaranteed rate of return each month, and it’s cash in their pocket each month. If your property will cover these extra payments and the vendor is willing to do it, then this is your best option. BUT – if I have no down payment at all, and can only get 75% financing from a bank, I wouldn’t use this method to finance the rest.
No money down real estate investing is VERY different than buying a property without using any of your own money for a down payment.
Let me explain… no money down is where you borrow 100% of the cost of the property. It’s incredibly risky because if the value decreases even by 5%, you will find yourself owing more money on the property than it’s worth. And if anything goes wrong you will find yourself pinched to pay for it. There are a lot of foreclosures happening all around North America for this very reason!!!
It’s also extremely difficult to find a property that will cashflow with 100% financing. And you still need money.Typically you can expect to need about 2-3% of your purchase price to cover the other expenses. It’s not a lot, but you have to pay a property inspector, a lawyer, property purchase tax and a few other disbursements depending on where you are buying.
No money down deals are not only MUCH riskier because you have no equity in the property, they are also pretty darn hard to find because they rarely cash flow.
If you have no money for a down payment on your real estate investment, then, in the following order, this is what I suggest:
1.Get control over your finances. Pay down your debt and start saving. You don’t need cash, but there probably aren’t many people that will partner with you if you are terrible with your money.
2.Look to your home. If you own a home, and have some years left before you were planning on retiring and a reasonable amount of equity in your home (over 25%), consider using a portion of the equity in your home to get started.
3. No money and you are currently a renter or don’t have enough equity in your home? Find a great property…one where the rent will cover the costs with as little as 10% down. Get an accepted offer and then find a partner that has the money to invest in the property with you. Be prepared to sell yourself AND the property.
We’ve bought several properties when we’ve had very little money ourselves. The no money down deals blew up in our face. Those were hard lessons learned. But, the deals we did with a partner, where we did all of the work finding and purchasing the property, and now oversee the property, have been a great success. Having money for a down payment allows us to buy better properties in better areas, gives us equity in the property from the start, and helps reduce the monthly mortgage costs so the property is more likely to cash flow from day one. The deal we typically make with partners: Our partner puts down the money for the down payment, but we jointly own the property 50-50. If we have to make major repairs, and the property can’t cover it, we split the cost evenly. When we sell, our partner will get his down payment out first, then we split the rest of the proceeds.