Everyone has his or her own reasons for investing in real estate, but there are five key reasons that probably cover all the bases. Real estate is the “ideal” investment vehicle and by that we mean:
Depreciation and Deductions
Let’s break down that acronym into its elements.
I for Income–a beautiful thing and the more you acquire the prettier the picture becomes. One of the beautiful things about real estate investing is that you can earn income over the long-term, but you can also make short-term profits. There are other types of income such as positive cash flow. For example, you can purchase a property and then rent it to tenants who not only cover your mortgage note and other expenses, but who provide you with a tidy profit every month.
That positive cash flow represents short-term Income, but you can also sell that property years later for much more than you paid for it – long-term Income. Invest wisely and you get the best of both worlds.
D means depreciation and as used here, it is a tax term which means allocating the cost of your property over its estimated useful life. When you purchase a property, it automatically begins to wear out. Its value is being reduced month by month. That’s a natural and undeniable fact of economic life. Because the value is declining, you get to write off some of that loss on your yearly income taxes. Real estate is a business and depending on the structure of your organization, you qualify for a whole range of other tax deductions.
E stands for equity, which is the difference in value of a property today and the amount you owe on it. If you own a $200,000 house, but have paid off $100,000 of it, your equity is the difference – $100,000. Equity grows over time so that someday that property will be worth $210,000 and more according to market conditions and demand. The value of that property also increases as you pay down that mortgage. Over time your equity translates directly into wealth.
A is for appreciation, which means the property grows in value over time. One of the great things about real estate is that property rarely declines in value. If you own real estate it will appreciate. And if you structure your deals properly, your investments will more than pay for themselves as you advance your career. It’s just hard to go wrong in real estate.
L means leverage and that’s one of the most important concepts you’ll encounter in this business. Basically it’s using some outside influence to increase your power. Most people think in terms of finance when the term comes up – using someone else’s money to make a purchase for example. But there can be other types of leverage, such as using someone’s influence to gain access to a person or a property.
Here’s an example of financial leverage in action. Suppose you purchase a house for $100,000. You wouldn’t want to use your own money even if you had the funds to do so. You’d want to use OPM, other people’s money. The down payment is $5,000 so you’ll acquire the other $95,000 from a lender. The average appreciation rate in the US for the past 35 years has been 6.34 percent while many areas are doing better than that. Using that average, at the end of a year your property increases in value $6,340. That money isn’t in your banking account. It’s in the property, but it is yours nonetheless. Assume for this example that you’re renting the property and your expenses are covered by rental payments. Your initial out-of-pocket investment was $5,000 and in just a year you’re already making money – a 127 percent return on your investment. Better than that, because you’re using leverage for the other $95,000 in the transaction, you’re actually earning money on the entire $100,000, not just your $5,000. That’s the power of leverage. Hype vs. Reality You can see a lot of television commercials and other advertising that promise great wealth in real estate with little or no effort, cash, or credit.
That sounds too good to be true, but if you’ve ever spoken with serious real estate investors, you know that great fortunes are being made. They’re being made by the people who (1) have knowledge and (2) put that knowledge to work in the real world. Make the effort. You have to make the phone calls to prospects and customers every day. You may feel awkward at first, but if you don’t make the effort you’ll never make the big dollars. Just do it. The more calls you make, the more people you contact, and the better you’ll become at the process. Many of those initial efforts can be considered practice.
A lot of deals will never jell, but the practice will start paying off in greater confidence, improved skills, and successfully closed deals. Just keep plugging away. The more you do, the more you learn and the more you can put that know how to work earning real wealth. The term “pretty house” and “ugly house” gets a lot of use these days. You can even see investors advertising that they buy ugly houses. What do those terms mean? In real estate a pretty house is one that is ready for sale. It’s appealing and can be put right on the market. An ugly house is a property in need of rehab work. The windows may be broken out, the doors broken or battered, the roof needs replacing, the yard is full of weeds, or it may be in need of serious work in any number of areas. One is not necessarily better than the other for investment purposes. The choice depends upon your marketing strategy and your goals. For example, it’s possible to purchase an ugly house with no money down and get enough cash back at closing to pay for your rehab work and still have a nice profit. But you have to put the knowledge you gain here to work and learn to structure your deals properly. What happens if your property is too ugly to attract the renters you need? Careful research, planning and execution of your strategy are essential elements of any transaction, especially one involving ugly houses. The hype you see on those commercials may be just that – hype. But for those who work at it, real estate is a great way to build tremendous wealth.
You don’t have to know everything to get started on that path, either. In fact, one of the best ways to learn the ropes is to get in there and start dealing right away. You can get started with limited resources. It’s even possible to purchase real estate with no money down and no credit. People do it every day. Think about making substitutes for the resources you lack. If you don’t have financing or credit, find a partner with access to those items.
Substitute your knowledge for money. Someone has income to invest and you have the know-how to make a deal work. Realize that getting rich in real estate isn’t automatic. Regardless of what the television gurus might say, success in real estate requires real effort. Something else the gurus fail to mention is that you’re going to make mistakes. Everyone does and that’s okay. It’s just part of any business effort. The trick is to learn from them and to apply that knowledge in your future efforts. So, where is the middle ground between hype and reality? The fact is that you can earn fantastic wealth in real estate investing, but no one becomes an overnight success. It just doesn’t happen. Someone can’t just attend a weekend seminar, pick up a little knowledge, and automatically turn that information into real assets. For those who study and learn and who put that learning to work, the sky is the limit. The bottom line is you have to take action. Don’t hold back. Even misguided action is a positive step because you’ll learn from your errors.
Take action and take it now. What it Takes to Get Started As you know, two requisite items are knowledge and the resource of a willingness to take action. You have to know what to do, how to do it, and then you have to actually do the work. What other factors are necessary? As a famous general once said, you can’t take counsel of your fears.
Action drives out fear and it’s how you learn the business. Some areas you’ll need to learn and take action on are:
• Inspections and inspectors
• Appraisals and appraisers
• Financing and loans
• Hard and soft money
• People skills
• Closing and closing skills
• Business skills
There are always methods to accomplish your goals even if you lack specific resources. Suppose you had an investment opportunity requiring a $20,000 down payment, but you lacked the funding. Is that the end of the game? It’s the end only if you refuse to act. Start calling the people in your network of real estate investors. You certainly know someone with investment capital who lacks the skill and knowledge or the time and temperament to handle an investment on his or her own. There’s your funding. Make the deal and then start looking for more deals. Build your network of contacts and investors. Find people with real estate problems and creatively solve them.
What does it take to make it in real estate? Here are a few specific areas for you to concentrate on:
1. Take action. Dreaming and planning are fine, but you must be willing to step out and make those dreams and plans work. Become a doer
2. Perseverance is an essential ingredient in the successful investor. You’ll make mistakes, encounter unexpected obstacles, endure frustrations and delays, but a successful investor never quits. He or she just “keeps on keeping on” no matter what happens. Embody the absolute determination to succeed.
3. Be a problem solver. You’ll encounter enough problems in the normal course of your business dealings, but you’ll need to find more. That’s right. You’ll want to find problems. People with investment money have a problem. You can solve it. People who are about to have their property foreclosed have a problem. You can solve it. Someone who has just inherited an unwanted property has a problem. You can solve it.
4. Be willing to ask for help and have the mental skills to use the feedback when you ask for it. We can leverage financing, but we can also leverage other people’s knowledge, skills, time and so on. Listen to the people who know and learn from them. Don’t fall into the “yeah, but that can’t happen to me” trap. Learn as much as you can from as many people as you can and then apply that knowledge to building your fortune.
5. Self-reliance is a critical factor. It’s the basic entrepreneurial trait. There are two kinds of people in the world: those you can count on to perform and those you can count on to not perform. Those that lack the entrepreneurial spirit fall into the latter category. Self-reliant individuals make for good real estate investors. They trust their own abilities to take action, make decisions, and achieve goals.
6. You’ll need to be able to tolerate ambiguity and uncertainty. This business is filled with it and that’s just part of the game. Uncertainty goes with the territory, especially in when you’re just starting out. It’s important to find a comfort zone in an uncomfortable business arena so that you can take action. A good investor plans and analyzes, but he or she is never the victim of paralysis by analysis. He or she accepts change, adapts as necessary and continues on toward achieving goals. If ambiguity and uncertainty make you nervous, real estate will be a tough environment for you.
7. Finally, a good investor is comfortable taking risk. Every investment in whatever field involves a certain level of risk and real estate is no exception. Risk is part of the equation, but it doesn’t have to dominate your efforts. There are numerous steps you can take at every stage of the process to reduce the level of risk. And all risks aren’t deadly. You’ll encounter moderate and calculated risks and this is where most of your risk taking should occur. You don’t want to completely avoid risk because you’ll never do anything.
On the other hand, you don’t want to continually take dangerous risks either. Find the middle ground and you will definitely move closer to a successful real estate career.
• Problem solving abilities
• Willingness to ask for help and willingness to act on that advice
• Self-reliance and self-confidence
• Tolerance of ambiguity and uncertainty
• Moderate risk taking
Through the learning presented in this course and developing the items mentioned in the above list, many have become successful real estate investors. Terminology “Investor speak” was mentioned earlier. You’ll need to invest some serious time and effort in learning the terminology of real estate.
You will need to know and understand the meaning of the words and terms in the following list. They’re defined for you in the Glossary.
• Adjustable Rate Mortgage
• Appraised Value
• Assessed Value
• Balloon Mortgage
• BPO – Broker’s Price Opinion
• Cash Flow
• Closing Costs
• CMA – Competitive Market Analysis
• Comps – Comparable Sales
• Deed of Trust
• Down Payment
• Earnest Money Deposit
• Escrow Account
• Fair Market Value
• FNMA or Fannie Mae
• FHA or Federal Housing Authority
• FHA Mortgage
• First Mortgage
• Home Equity Line of Credit – HELOC
• Home Inspection
• Lease Option
• Legal Description
• LTV – Loan to Value
• Mortgage Broker
• Negative Amortization – NEG AM
• Offer and Counteroffer
• Owner Financing
• Principal, Interest, Taxes and Insurance – PITI
• PMI – Private Mortgage Insurance
• Purchase Agreement
• Real Estate Agent
• Second Mortgage
• Settlement Statement
• Title Company
• Title Insurance
• Title Search
First, realize that most transactions represent a “traditional deal” in which the buyer wants to live in the house being purchased. It involves a buyer, a seller and a number of professionals along the way. Investor deals are something else all together. It may involve buying property from the owner or from another investor and the purpose is to earn money from the investment. Investor deals are often made by entrepreneurs who are comfortable working out of the box, in unusual or creative ways. The mechanics in both deals are very much the same, but the interpersonal dynamics are very different. The Contract Drawing up and signing a contract on the property is the first tangible thing that happens. A contract must reach certain standards if it is to be legally binding and in most markets you can find a standard form produced by the Board of Realtors® for that state. Of course there are other forms and some investors use different forms for different purposes, one for when they buy and one for when they sell, for example. These non-standard forms tend to make most professionals nervous, so when possible, it’s a good idea to begin with the approved standard form and then make modifications to it as you need.
Some of the items required to make a contract legally binding follow.
• It must be bilateral, that is two parties must be involved and both parties must agree to the conditions in the contract.
• The contract must be set in writing.
• The parties must be clearly identified, for example, John Doe of 123 Easy Street, Denver, Colorado or Richard Roe of ABC Realty Investors, Denver, Colorado.
• It should clearly identify the property. (This may require a legal description, not just a street address.)
• A price must be specified.
• It must contain consideration, which is the benefit, interest, or value that induces a promise. You have to give something of value for the property. Earnest money is consideration and there are no specifics as to how much money or what percentage of the purchase price must be put down as earnest money. If the contract includes a liquidated damages clause, it stipulates that if the buyer backs out on the agreement the seller is allowed to keep the earnest money.
• Signatures of both parties are required.
• A contract will contain inclusions and conditions. Inclusions are anything you and everything that you might get into a dispute over later in the process. Inclusions cover as many details as possible. For example, the contract might have an inclusion stating that the kitchen appliances come with the purchase of the house. Anything that might come up later can be addressed in as many clauses as necessary.
• The working order and condition of the property should be addressed and if the seller is to be responsible for correcting the situation, that too should be included.
• Timetables are an important part of the contract. Deadlines for inspections and appraisals are typically included. For example, you might make an offer with an expiration date of 5 p.m. the Friday of the week you submit it. Every step in the process should be laid out step-by-step, timeline by timeline. Timelines are a flexible item, and you should negotiate them according to your favor.
Contracts may be changed using an amend/extend document, which states the change and is signed by both parties. It’s not a good idea to enter a contract with the notion that you will change it as you go along. Get as much of the document “set in concrete” right up front.
Never forget that you are ultimately responsible for the contract you sign. Understand every bit of it. Don’t depend on the Realtor®, lawyer, accountant or anyone else because, ultimately, you are the one at risk. These are just the basics. You can add any number of other clauses to your contract. It is essential that you thoroughly read and understand the elements in any contract you sign. If you don’t understand, get clarification before you sign. Due Diligence Doing your due diligence is doing your homework. It’s when you start analyzing a property to determine if you want to make an offer on it.
You want to know (1) if you want to buy the property, (2) what type of financial evaluation you’re going to do, and (3) your exit strategy. Here is a key difference between a savvy investor and a novice investor. The savvy investor will see a likely property and immediately get it under contract – tying up the property as quickly as possible even if they haven’t inspected it. A novice will invest a lot of time checking the property and looking into the deal, meanwhile someone else who takes action will step in and lock it up.
Here’s how to make due diligence work for you.
First, get a good potential property under contract, fast. When you write up that contract include contingencies that give you exit options if the property doesn’t turn out as you hoped it to be. Think of a contract as a way of saying “dibs” on the property. “This real estate is mine.” Then it’s time to conduct serious due diligence to see if you want to keep it. There have been recent changes in some state laws surrounding contingency clauses. It’s always a good idea to consult with your attorney.
There are two kinds of inspections, and you’ll probably want to conduct both, or have them conducted by professionals for you.
1. Personal inspection. This is when you take a close look at the property to determine if you want to pursue a purchase. 2. Professional inspection. This is handled by a professional who thoroughly inspects the property and issues you a written report on what he or she has found. This is extremely useful information. It may prevent you from buying a property that will be difficult to sell or that will hit you with a lot of problems. You might also be able to use the report to get a better deal. For example, if the roof is damaged you could ask for a price reduction.
If you’re planning a rehab, you’ll want to know exactly what you’re getting into and the inspection can give you a heads up on what you’ll be facing. There are three categories in this inspection.
1. Problems that sound worse than they are. These are items that can be easily fixed, such as removing stains.
2. Problems that sound bad and are harder and more expensive to fix. Replacing an old furnace is a good example.
3. Problems that are bad. These could be structural problems or some other serious issue. When conducting inspections, you should be concerned with both what you find and how your plans will be impacted by what you find. Conduct due diligence on your lending, too. It’s important to stay on top of all the details of your financing and that holds true even if you aren’t on the loan that’s being handled by a financial partner.
To overlook financial due diligence is to invite trouble and perhaps disaster. One of the great frustrations in real estate is to conclude a great deal with a seller only to have it fall through because you didn’t follow up on your financing. Title work is an important part of due diligence. Although this task usually takes place behind the scenes, you’ll want to stay on top of the situation all the way through.
A title company will conduct the research and examine the chain of tile of who has owned the property over time. They will find out if there are any encumbrances or ownership problems. Make it a point to check in from time to time. At the end of the process, they’ll issue title insurance, which essentially confirms that the seller owns the property and has the right to sell. The appraisal requires due diligence. Appraisals are usually conducted by licensed appraisers. They will use recent comparable sales in the same area to help determine the market value of the property. These figures are often called “comps.” Other factors such as the number of bedrooms, the location, or the size of the lot will be considered too. If you don’t have an appraiser on your team, you can probably use one of the appraisers who work with the mortgage broker. Eventually you will work with enough appraisers that you’ll find the ones you prefer to work with. The last element of due diligence is analysis and strategy. This is where you answer a series of important questions. How much is this property worth? Am I actually going to make this purchase? How much am I going to put down in earnest money? What am I going to spend on it to increase its value? How much can I get for it when I’m ready to sell? Take all the information you have and begin analyzing the situation. Keep in mind that this process appears backwards to what many people think of as a logical approach. To some, putting a house under contract and then inspecting it seems crazy. But that’s how you do it. If you don’t tie down a good-looking property, someone else will.
The last step to take is called closing, which is when ownership of the property passes from seller to buyer. It usually occurs in the title company offices or an attorney’s office. In some states you can even close by mail. Closing is the moment that transaction takes place. Also, the process itself is called the closing. HUD-1 Categories and Charges A HUD-1 is a document used at closing and it’s from the Housing and Urban Development Department of the US Government. In real estate terminology the document is often referred to as “the HUD.” The document is used to sort out all of the financial transactions that take place at a closing. The wide variety of financial dealings that are involved in a closing.
• Purchase money is coming in to the seller
• The seller is using some of that money to pay off his or her debt and loans, such as a second mortgage or mechanic’s lien.
• Loan broker fees
• County recording fees
• Title fees
• Survey fees
• Utility payments
• Earnest money is applied to the down payment or the loan
• Reserves are put aside for future taxes and perhaps insurance All these, and perhaps other costs, are accounted for on the HUD. When seeking financing your mortgage broker is required to provide you with a Good Faith Estimate (GFE), which is an estimate of all the charges so you can have a reasonable idea of the financial step you are about to take. If time permits (and sometimes it doesn’t) its a good idea to get a copy of the HUD before closing so you can go through it line item by line item. It’s sometimes possible to get a fee deleted because it’s higher than the estimate or it has been added to the estimate. An advance copy allows you time to study the charges and, if necessary, draw up a list of questions about them.
These are the basic elements of a HUD-1:
• Section 100 is the gross amount due from the borrower.
• Section 200 is the amount paid (deposit or earnest money) and the principal amount of the new loan.
• Section 300 is the cash at settlement from or to the borrower.
• Section 400 is the gross amount due to the seller. Other items such as taxes, utilities, HOA fees, and assessments fall into this category.
• Section 500 is reductions in the amount due to the seller. Everything paid out of the seller’s money goes in this section. • Section 600 is the cash at the settlement to and from the seller.
• Section 700 lists the total commission paid.
• Section 800 lists all items payable in connection with the loan, such as a loan origination fee, credit report fee, or other fees.
• Section 900 covers items required by the lender to be paid in advance, such as mortgage insurance premiums or hazard insurance premiums
• Section 1000 lists items that are reserves deposited with the lender.
• Section 1100 covers title charges and any costs related to the title company, title search, and so on.
• Section 1200 lists government recording and transfer charges. The last step in the process is the recording of documents by the county government. The HUD-1 is a complex document and it can be confusing, especially for beginners, but you’ll get used to it. Don’t be intimidated by this or any other real estate document. Learn it. Understand it. And realize when you see it at the closing that you have arrived at a very happy moment – the moment when you get the keys and take possession of your new property. When evaluating a property, do as much as you can as early as you can.
One of your goals is to rule out a property before you start spending money on your evaluations. For example, it’s far better to eliminate a property from your list of potential purchases before you make the investment of $1,000 or so in inspections. Evaluation is a four-step process. The order is not always the same and in some cases, the categories overlap each other. You’ll need to understand all four regardless of the overlapping areas or the order in which you go. These steps are:
• Get control of the property.
• Look for reasons not to buy the property.
• Determine the market value.
• Do your due diligence.
Step #1: Get control of the property. Put it under contract. There’s no use going further if you don’t have the property tied up. With a fully executed purchase agreement on a property, you are in the driver’s seat. No one else can buy the property and you only have to buy it if you decide to do so.
Step #2: Look for reasons not to buy the property. This is the cardinal rule of doing an evaluation. Avoid the mistake of justifying a decision. It’s easy to get caught up in the excitement of buying and selling property and that can lead to overlooking some aspects of the deal that could cause you real problems. Don’t get so excited about making a deal that you make a bad one. Investors, especially novices, are encouraged to master Excel spreadsheet or some other spreadsheet software. It will save you hours of time making calculations and recalculations. It will also spare you a lot of headaches. Consider all the costs you’ll be trying to calculate and how much trouble you’ll be letting yourself in for if you try to do this with a pencil, a tablet of paper and a lot of erasures:
• Purchase price
• Purchase costs
• Closing costs
• Fix up costs
• Holding costs
• Marketing costs and sales commissions
• Contingency funds
• Other expenses that pop up from time to time
Spreadsheet software will make entering and changing those figures much simpler and your evaluation process considerably easier and more accurate.
Step #3: Determine the market value. What can you sell this property for? How much profit can you make on the deal? That’s a pretty important step, because if you can’t earn enough profit on the transaction, why bother making it? Remember that the definition of market value is really whatever sum a buyer is willing to pay. If every comparable house in the neighborhood sold within the last six months for $200,000, but you can only find a buyer if you sell it at $175,000, then $175,000 is the market value. There are a number of resources available to help you determine a realistic figure. You can visit your county records office and get the tax assessment for the property in question. In the assessor’s office you can see that the tax on the property was X because the property is valued at Y. That’s a good start. Some investors through a lot of research learn the value ratio in their market. For example, in a given neighborhood houses might be valued at ten percent higher than the assessed value. If you want to use this formula, be sure to conduct careful and in-depth research into your own market first. You’ll want to get comps, too. How much did similar houses in the same area sell for in recent months? Those numbers will provide a reasonable guideline for making an evaluation. As previously noted, when you hire an appraiser he or she will include comps in the written report. If you’re holding off hiring the appraiser till you make up your mind, a good idea, you can get information on comps from the Realtor® you’ve hired or from some other source that has access to comparable sales.
When looking at comps, it is essential that you “compare apples to apples.” The more similar the houses you’re using for comps are to the property you’re considering, the better and more valid the comparison. Also, the closer the comps are to your property, the more accurate they’ll be for the purpose of evaluation.
Two bits of information can be very helpful: BPO & CMA BPO is an acronym for Broker’s Price Opinion. It’s an estimate of what a real estate broker thinks a particular property is worth. A CMA is a Comparative Market Analysis which compares your target property to the competition in the marketplace. CMAs are often used by real estate agents to get seller’s to sign with them and can therefore be somewhat inflated depending upon the ethical standards of the agent. You are advised to be careful when using CMAs to evaluate a property. Take a careful look at the condition of the property. Is it a pretty house or an ugly house? Regardless of which category it falls into, do you believe you can earn a profit on it? If it is ugly, how much must you spend to make it pretty? Are there features that make the houses desirable or undesirable? It’s important to include the pretty/ugly factor in your evaluation. For example, a house with favorable comps still might not bring as much profit or sell at all if it is an ugly house. When you do get to the appraisal stage understand that you will be getting what’s known as an as-is appraisal. Keep in mind that if you do a lot of fixing up on the property, its value might be raised well above the as-is evaluation. Use as many resources as you can. Get all the information you can. This is one area where you really want to do your homework. Visit the property with your Realtor® and then tour similar homes in the area. Look at the competition and see how it will affect your efforts. What makes them appealing? What can you do to the property to make it appealing? What do you need to do to make the property competitive? Can you do that and still earn a decent profit? Don’t rush this process. Take your time and cover all the bases.
Step #4 is due diligence. Due diligence includes your inspections of the property. You’ll learn which kind of situations you’ll encounter: things that (1) sound bad and are cheap to fix, (2) sound bad and are expensive to fix, and (3) are really bad. Take the results of the inspections and begin fine tuning your evaluation. Conduct a market analysis. What’s selling in the area and what’s not moving? Why? What can you do to make sure your property will move? If you’re working with a Realtor® you can get a lot of information from the MLS book. The appraisal will also have a lot of valuable information, too. One area you want to look at closely is the DOM, which stands for Days on Market. How many days has the property been for sale? This number can be telling. For example, if you see a house listed for $139,000 and it sold for that amount within a week, you’re probably looking at a healthy prospect in a healthy market. If the house was listed for $150,000 and was on the market for more than 90 days and then was offered for a reduced price, you might be looking at an entirely different type of market. Try to get as much information as close as possible to the property you’re considering, not just citywide data. As you move through the process you’ll come to a point where you need hard data on the cost of rehabbing the property. There are two ends of the spectrum: cheap and costly and you can shoot yourself in the foot in either area. If you try to get by “on the cheap” by skimping on rehab or not doing much rehab at all, you could end up with a property that won’t move. Look at the property from the perspective of the person who will rent or buy it. You must do enough rehab work to make the property appealing to the people who come walking through the door. Most novice investors make their mistakes at the other end of the spectrum, on the expensive side. They purchase a property and invest so much money in making the property a “showplace” that there’s no way to earn a decent return on the investment. It’s a good idea to take a class on how to rehab a property before you take on the task. That way you’ll have a much better chance of hitting the right balance in fixing up your property. If you’re planning on renting the property, be sure to conduct a rent survey of the neighborhood. Unfortunately, it’s unlikely that a ready-made rent survey exists in your market, so you’ll have to get the information through good old-fashioned leg work. Check the real estate section of your local newspapers. Don’t be afraid to ask people in the neighborhood or to call up apartment buildings and apartment owners to get a handle on how much rents are in the area.
The last area under due diligence is lending.
If you have the property under contract, obviously you’ll need to acquire financing to make the purchase. Talk to your mortgage broker about the available options. Do you want or need a 30-year fixed loan paying principal, interest, taxes, and insurance or an interest only loan? Should you consider an option Adjustable Rate Mortgage (ARM) probably not in an inflationary environment? In this instrument one of the options for payment is interest-only. It doesn’t even pay all the interest that’s amortized for each payment. Each month, a small amount of interest that you haven’t covered gets added to the back end of the loan. The loan principal increases over time. This is called negative amortization, or “neg-am.” Investors love it because a neg-am dramatically keeps monthly holding costs down.
Keep in mind that throughout the evaluation process you’re looking for reasons not to make the purchase. You’re not only trying to build a worst-case scenario into your estimates, you trying to build a worst, worst case scenario. If something goes wrong with every item on your list will you still be okay doing this deal? A real estate investment ties up more than just your money. It ties up your time, credit, the credit and/or money of your partners, your energy, and sometimes your emotional strength. Is the deal before you the best use of all your resources? Contingency Clauses The contingency clause is one of the most powerful tools in your real estate “tool kit.” It’s your ace in the hole and get out of jail card free all rolled into one. To use them properly you have to understand them.
The lesson of contingency clauses is the number one lesson beginning real estate investors should learn. Why? Because the number one issue facing new investors is fear. Contingency clauses are a means of minimizing the fear by minimizing the risk. Obviously, your lawyer should review all contracts including the contingency clauses. A contingency clause is a condition that must be met before a contract becomes legally binding. The most common one is a clause that states the contract is not binding until the buyer obtains a satisfactory home inspection report from a qualified inspector. If the report is negative, you can flip out your ace in the hole (contingency clause) and get out of jail (the contract) free (at no cost). Another common clause states that the contract is contingent upon the buyer being able to secure adequate financing to complete the transaction. One way investors can get into trouble is in missing deadlines. If a deadline passes and no action is taken, you could lose your right to exercise that particular contingency. For example, if the clause states that you have three days for an attorney review and three days pass without that review taking place, you lose that specific ace in the hole. The inspection clause is one of a number of so-called weasel clauses. These are conditions that allow you to “weasel out” of the deal. For example, you could include a clause stating that you are allowed ten business days for your attorney’s satisfactory inspection and approval of the contract. That gives you a free look at the property while your attorney, accountant, partner, or whoever reviews the agreement.
Again, it’s important that you understand these potential clauses and that you have your attorney review them as each state can differ. Otherwise, they might come back and cause you grief later on. Some clauses can be quite open-ended. For example, you might make the sale contingent upon the approval of your partner. He or she can nix the deal if something doesn’t meet his or her approval. Notice that you haven’t made the deal contingent upon structural soundness or really anything of substance at all. If your partner doesn’t like the color of the interior paint (or whatever), you can bail out of the agreement. As a buyer, you want as many such clauses as you can get because you’ll be moving into uncertain territory. When you put the property under contract you really don’t know what you’re getting into.
But be careful about overdoing the weasel clauses. Word gets around in the community and if you make too many people angry you could find it hard to find people to deal with. Also, an indiscriminate use of weasel clauses could open you up to lawsuits. Always check with your lawyer on contract matters and try to strike a fair balance that protects your interests but does not create potential problems with your sellers. Always protect your reputation as a savvy investor. Use these clauses judiciously and with a purpose. Another clause could state that the contract is contingent upon inspection of the property by the buyer and a written acceptance of the condition of the property with in a specified number of days. Again, this is a pretty open-ended clause which allows you to bail out of the deal for any number of reasons. There are a number of other clauses you might put to use, such as a financing contingency that allows you a certain number of days to acquire financing.
An insurance clause could be inserted stating that the contract is contingent on the buyer obtaining sufficient insurance on the property. Compliance with the current building code in the case of recent remodeling could be a clause. The seller must provide documentation that the remodeling was up to spec. In areas where the soil isn’t always stable, you could insist on a soil report or a flood damage assessment as part of the agreement. If the property fails to pass inspection, you can bow out of the deal without risk. When you enter into a contract, it is assumed that you are doing so in good faith and that you are not going to use your weasel clauses to get out of the deal for reasons other than those stated.
Good real estate deals are win/win scenarios. Your goal with the use of contingency clauses is to minimize risk. Let your guiding principle be fair play. Section 4 PROBLEMS AND OPPORTUNITIES Your greatest opportunity to earn a profit in real estate is when there is a problem. Becoming a problem solver is your way to wealth through real estate investing. Wherever there is a problem there is an opportunity to make money, especially if you solve a problem someone else can’t or hasn’t yet solved. Maybe other investors are just as capable of finding a solution to the problem, but if you’re the first one on the scene you get to become the hero. There’s one caveat. Make sure the problem is solvable. You don’t want to adopt a problem which will cause you to lose money. The depth of a problem may not at first be apparent and that’s why it’s important to do your homework. For example, suppose you come across what appears to be a great deal. Someone has a problem in that he or she needs to unload an old house, one that’s been around for a hundred years or so. The property is quaint, appealing, and in a decent neighborhood and you’re interested in making a purchase. During your inspections you learn that the house is structurally unsound. It will collapse within a decade. Are you going to buy that property, invest rehab money in it, and then sell it to someone knowing that it’ll fall apart within ten years? No. That’s a problem you don’t want to adopt. People Problems Fortunately, many, many problems in real estate lead to profit, even great profit. The best types of problems are people problems because they’re easier to solve than problems that relate directly to the property.
Real estate professionals are always looking for people with problems because people with problems are motivated sellers. What are some typical people problems?
• A death in the family. Suddenly someone is stuck with the problem of selling a house.
• A move. For any number of reasons someone could be moving from one side of the country to the other. He or she has to buy a new home in the new neighborhood, but is stuck with the old home in the old neighborhood.
• Someone is ill or has had an accident and can’t afford to keep up with the house payments or has to move in with family or even a nursing home.
• A business downturn. Changes in a job, such as downsizing or a move to another location, can be a real problem. A change in income often dictates a change in dwellings. You have to keep a clear head about you and adopt the right attitude in these situations. Remember, you’re not a vulture sweeping down to take advantage of someone’s misfortune. You’re a problem-solver, a knight in shining armor rescuing someone from a terrible problem. You had nothing to do with creating the crisis they’re in. You’re just stepping in at the right moment to bring some welcome relief to a tough situation.
Problems and profit go hand in hand. You earn good money by solving bad problems. As the knight in shining armor, you’re rescuing people in real pain. For whatever reason, they’re suffering and your arrival signals the end or at least the relief of major stress. You’re the good guy. You should also remember that motivated sellers aren’t selling a house, they’re buying relief. In their minds, that relief is worth far more than the price of the sacrifice they’re making. One of the reasons solving people problems is easy is that they’ll often tell you what they’ll take for the house right off the bat. Suppose the value of the property is $160,000 and they owe $120,000 they might speak right up and say, “We’ll take $130,000 for it.” This is a win/win scenario. The seller buys relief from a terrible problem and you purchase a good property at a good price.
House problems generally fall into one of two categories: • Cheap problems • Expensive problems No house is perfect and chances are there will be some problems with any purchase. Many of these problems can be handled without a great expenditure of money. The fix up is cheap. Some examples of cheap problems are paint and carpet. Almost any home you buy will need new carpet and a new coat of paint. Landscaping is another area where you can get a great benefit from a small investment. Curb appeal is one of the first things that attract or repel a buyer. Lighting is another problem that can be solved cheaply. New lighting fixtures and bulbs that throw off a lot of light cannot only brighten a room, they can brighten your financial picture.
Cheap problems are generally solved in a short amount of time. Buy the house. Schedule the work. Get it done and turn the property. Because these problems aren’t very complex, you can solve them quickly. The downside is that if you’re buying a house with these types of problems, you’re probably not buying it at a substantial discount. Expensive problems can be anything that relates to the structure of the property: the foundation, roof, walls, electrical, or plumbing concerns. These situations are more expensive and more time consuming. You’ll also have to get building permits so that this type of major work is up to the city code. These projects are more complex, require more investment, will take longer than solving cheap problems, and generally involve more risk. It’s important that you budget carefully and that you adhere to your budget. There is an upside. Chances are a house with serious problems will be sold at a substantial discount. Understand that cheap problems and expensive problems aren’t necessarily good or bad. That’s determined by how the numbers work out for your project. If you can earn a good profit on a property with expensive problems then it’s a good deal. The “Aunt Helen” Rule You can take a lot of very simple steps that will have a powerful impact on the impression your property makes. People notice certain aspects of a property and if impressed by them, they’re more likely to overlook some other aspects that might not be as strong as you’d like. For example, Aunt Helen, an experienced rehabber, would use rubbing alcohol to clean kitchen and bathroom faucets until they sparkled. Faucets are one of those little things people notice right away. If they’re clean and shiny that impression is imparted to the rest of the house. The Aunt Helen rule is to create the right impression with small steps that require remarkably little time, effort, or money.
Another good rule is to think like a romantic. In a very real way you will be “romancing” the renters or buyers who come to look at your property. You want the property to look better, feel better, and live better. Put yourself in the mind of your prospect. What will make you happy about this property? What will attract your attention? What will motivate you to accept the offering? How can you create the right feeling so that the prospect falls in love with the property the minute he or she walks through the front door? Feeling is an intangible, but you want to do whatever you can to make your prospects feel good about your property.
Ten Rules to Profit in Real Estate Investing
Here are ten tested and proven rules for successful real estate investing.
Rule #1: Be willing to make offers even if you’re not sure that you really want the property. This is perhaps the most important lesson in this entire course. Do whatever it takes. You can’t make things happen until you make offers.
Rule #2: Understand that you make money when you buy. Appreciation is great, but you can’t count on it. If you aren’t making money when you buy a property you’re just speculating. If you buy a $150,000 house for $100,000, you will make money on the deal, even if you have to undergo rehab expenses. But if you buy a $150,000 house for $150,000 in the hopes of earning a profit on appreciation, you may be buying trouble. You can’t control market conditions which could easily take a nosedive without notice. Make sure to make smart purchases because that’s the point where you make your money.
Rule #3: Build a network of contacts and take good care of your network. No one earns real wealth in real estate on his or her own. Even a “lone wolf” needs a wide variety of suppliers and associates. Get to know other investors, how they work, how they think, what’s important in their eyes, and how they do what they do. The adage “it’s not what you know, but who you know” certainly applies in real estate. Get to know mortgage brokers, title people, appraisers, Realtors®, and the other people you’ll need to further your (and their) career.
Rule #4: Partner for success. Find partners who can compensate for areas in which you are weak. If you lack money or credit trade your knowledge, experience, and drive for those items. Don’t fall into the mental trap of thinking that if you take on a partner, you’ll only make half as much. Partners are a way of duplicating yourself. You’ll have more resources to make more deals and earn greater profits.
Rule #5: Plan your work and work your plan. That may sound trite because you’ve heard it so many times, but it is advice that works. There’s a reason those adages have been around for so many years. Develop a clear and concise vision and plan to attain it. Write out specific goals and set benchmarks so you can measure your progress. Create a plan that will help you achieve those goals and review that plan periodically to make sure you’re staying on track.
Rule #6: Treat your business as a business. Real estate investment isn’t a hobby. It’s serious work offering serious rewards. Even if you’re starting out as a part time investor, set regular business hours and keep them. Keep accurate and up-to-date business and accounting records. One of the most important steps you can take is to choose your investments according to preset criteria rather than falling victim to the emotions of the moment.
Rule #7: Hire professionals and take their advice. As a business author wrote, you don’t hire Michelangelo and then tell him how to paint the ceiling. You will need professional support in legal, accounting, financing and in other areas. Find the best people. Hire them and then pay attention to what they say. The arena of real estate investing is just too big for one person to know all the angles or to keep up with the changes that are constantly reshaping the industry. This is not an area where you should scrimp on the budget.
Rule #8: Find as many ways to add value as you can. Don’t limit your income potential with limited thinking. You don’t have to stick with just one type of project. There are many ways to add value. Seller financing or selling the property as a lease option are two proven methods. Maybe there’s a spare room that you can convert into another bedroom, which would up the selling price. Get creative. Use your imagination. Always be on the lookout for ways to add to the value of the transaction and increase your profits from the deal.
Rule #9: Put yourself in the mind of your buyer or tenant. How do they view the property and the transaction? What can you do to make things more attractive?
Rule #10: Never stop learning and this is the most important rule of all. When creating your schedule for finding properties, negotiating deals, rehabbing properties and all the other tasks you’ll take on, be sure to schedule plenty of time for continuing your education. Every penny, nickel, dime, and dollar you invest in education will repay itself again and again throughout your career.
The Success Mindset
The reason so many people fail to take action on the real estate knowledge they’ve acquired isn’t lack of capital or that they don’t know what to do. The reason they never act is fear. Fear, understood and controlled, is a strong ally. After all, fear makes us cautious and as long as that caution doesn’t cause paralysis, it’s a good thing. People have all kinds of fears when it comes to real estate. They have fear of losing money, fear of making mistakes, or fear of looking stupid in front of others. Of course, the most stupid mistake of all is to let fear shut you down. We all have fears and that’s only natural, but we can’t allow fear to prevent us from profiting from our knowledge. Take action because action drives away fear. Find out what you need to get you moving and keep you moving. Perhaps you need a partner to share the burden and to provide moral support when you’re down. There are plenty of people in real estate looking for talented partners. You could also use a coach, a buddy, or a mentor. You need knowledge to succeed in real estate investing, but here’s a secret about knowledge. You don’t need all the knowledge in the world to succeed. You just need enough to begin and a source for the information you’ll need along the way. Your knowledge base will grow as you grow. Play the “what if” game. What if this or that happened? What would be the consequences? How should I react? And what would be the consequences of that reaction? Always have a Plan B ready so that you can adapt to any changes, challenges, or opportunities that come your way. Understand why you want to make real estate investments. Do you want to earn fantastic wealth? Do you want to build long-term security for you and your family? Are you driven by the desire to create a business empire? What’s your motivation? Is that why important enough for you to step out and start doing what you need to do to succeed in this business? Is that why important enough to motivate you to start making offers – right now? Understand that the first offer you ever write will be the most difficult, but understand also that each one will get easier and easier until the process is practically second nature.
Commit yourself to taking action immediately. Get in the mindset of making decisions and carrying them out. You’ll be amazed at the success that your efforts bring. Start small if you have to, but start and start today. In closing, here’s a credo you can adopt, a credo that you can think on every day, and a credo that will help you get through the challenges that come every day.
It has three parts:
• The first part is to take care of business. Whatever you mean by “business,” take care of it. Don’t neglect certain essential tasks because they intimidate you or they might not be the most exciting things you’ll do. Some jobs you just have to get up and do and that’s especially true of the hard things. Do them first and get them out of the way, and this will free up amazing amounts of mental energy. Take care of business.
• The second element to the credo is live life well. Do whatever you can to make every day a great day so at the end of the day you can truthfully say, “Wow, this is really living!” In your job, your investing, with your family and community, live each day to the fullest.
• Part three of the credo is to live a fully self-expressed life. The concept is to devote your life to doing what you are good at doing and at what you love doing. Embark on a journey that allows you to use the skills you have to their best advantage and in ways that bring you real joy. What a fantastic way to live a life. Investing in real estate is a great life full of opportunity and rewards, and you will reap more of them when you express all of your gifts and talents.
Use what you know to solve what you don’t know and use what you learn along the way to build and grow inside the business.