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- Asking Price: $130,000

- 9 Units (7 apartments, 2 business)

- 1 apartment rented ($500/month)

- Two business suites rented ($1500/month)

- Potential rental income: $5,150 per month

The analysis was performed on a new iPhone application for real estate investors called NestVest.   It’s in advanced-beta right now but from what we’ve seen it’s really nice. You can use the Business Modeler to do the analysis.

Assumptions:

Assume the worst: the building needs a lot of repairs and only the 3 occupied units can only be rented at this time. When our rehab crewstarts, they will be able to rehab the empty units.  During a six month rehab project, our rental income is $2000/month.

Analysis:

By doing a quick analysis, we can see that even with only 3 units occupied we still meet all our expenses.

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With the numbers provided, we’re looking at $354/month in positive cash flow with only 3 units rented.

How this might work:

The property requires some TLC. How much?. Assume the worst; then we could figure out if this would still be worth it.

• Entire plumbing/electrical needs updating.
• New Drywall, New Flooring
• New Fixtures/Appliances (bathroom and kitchen)

The dollar amount now depends on what path you wish to take.   Do you renovate the entire investment all at once? Or one unit at a time?

Let’s start with the all-at-once renovation.  Based on the assumptions above, it would not be unreasonable to think the renovations would cost around $50,000 ($10,000 per unit).  Even though the ad says the renovation costs will be low due to the low square footage of each apartment, plan for the worst.

With the renovations at $50,000 and a potential increase of cashflow of an additional $3,000 then the ROI on that investment would be 72%.   After finishing the renovations, eighteen months later and the renovations will pay for themselves.

If an investor did have $130,000 to buy the property, would they have an additional $50,000 to renovate all at once? With contractors having a habit of walking off the job, the owner could find themselves with a building that isn’t livable let alone rentable.

One unit at a time might be more feasible.  The cost to renovate one unit is much lower than renovating an entire building. This has the benefit of being able to cherry-pick which apartment to renovate first.   Go for the easiest, fastest renovation. Once the renovation on the unit is done, rent it out.   Gain that extra $500/month and start rehabbing the second easiest unit.  Rinse, Repeat.

Summary:

This rental property investment analysis makes sense on paper.  It is just an issue of finding out all the hidden problems and determining the extent of the repairs that are required.  Did the previous owner let the property go bad? Is it the casualty of a divorce or lawsuit?   A very intense, thorough inspection would be required.

The biggest obstacle is financing the deal.   The seller seems intent on cash-only.  This would block 90% of potential buyers, even if they were experienced.   Also one big reason for buying real estate is for the write-offs come tax time.  Paying cash for a property, unless it’s a loan, provides none of the real benefit of real estate.  Maybe after sitting on the market for a while, the seller might relent and accept financing terms as part of the deal.

If you’re not watching, you should.

The premise of the show is easy.  Young couple buy a duplex.  Young couple make bad decisions.  Young couple call HGTV for help.

Enter the dashing Scott McGillivray.  He flashes his million dollar smile, and sprays mace into the drooling wife’s face.

On his entry, he examines the couples rental unit.  Typically these places are disaster zones.  The term “Cruel and unusual” punishment seems to apply.  After taking a tour and seeing all kinds of gross things (mold, dead birds, crack pipe) we’re treated to a Monty Hall “Let’s make a deal” style show.

Scott presents two scenarios.  One is always labeled “The Lipstick Job”.  Typically cosmetic, the changes promise to lift the value slightly and get the place rentable.  Option two is the Uber-renovation.  Jaw-dropping,  incredible, holy cow I-won-the-lottery cool.  It involves a complete gutting of the rental unit but the results are nothing short of heaven on earth.

Then the couple gets to choose:  The Lipstick job or the Uber-Reno job.

It never ceases to amaze me how people pick the Lipstick Job.  Their reasons typically make no sense.  One young couple buys a 3-story house with basement.  Scott gives them the lipstick option and the uber-option.  Uber-option results will product rent that will make their mortgage payment.  Imagine that!  Living mortgage-free in a duplex!

Nope.  The couple opts for the lipstick renovation.  Why?  They need five bedrooms.  What for?  Their dog and two cats?  Well, they probably aren’t serious real estate investors.

Some people, you just want to cheer for.  We watched as Samantha and Andrew were just about to to lose their house before Scott and his pearly whites showed up.  They opt for the Uber-Reno.  Why?  “Because we want it done right.”  In the end, they get $1000/month for their new apartment which is $150 more than what the Uber-Reno model said.

There are a few things you can pick up from the show.

1. When buying a duplex, always renovate the rental unit first.  The mortgage payment is going to come whether you have a renter or not.  Doesn’t it make sense to have a tenant to help out immediately?
2. When doing a renovation, go with hardw0od or tile flooring.  To put some numbers to this: let’s say it costs $800 to install carpet but $1200 to install tile.  Most people pick carpet because it’s cheaper.  Well, carpet has about a 3 year lifespan.  Hardwood/tile floors have about 15 year life span.  Carpet you’ll be replacing; hardwood/tile floors you won’t.
3. Every renovation decision needs to be dictated by the ROI.  Why spend $20,000 on a renovation if it’s only going to raise rents by $10/month?
4. You can be on the show.

Watch:

The number one blockade to getting people onto the real estate investing wagon is their credit card debt.  It affects all kinds of things, such as the amount you can ultimately borrow from banks.  What we are going to do is take a look at the "expert" advice and tweak it to eliminate your debt in a fraction of the time.

Expert’s Advice:  Pay as much as you can towards your biggest credit card.  Pay the minimum amount due on all your other credit cards.

Cliff’s Advice:  Pay as much as you can towards your biggest credit card.  Pay the same amount due on all your other credit cards.

Whatcha talkin’ about Willis?

Let’s talk about your car loan.  A bank loans you a certain amount of money, at a certain interest rate, and a loan term of X amount of years.  "Five year financing with 2% interest" pepper car commercials.  Home mortgages work the same way.  Every month like clockwork, you receive a bill for the exact same amount.

Credit card companies loan you a certain amount of money at a certain interest rate but with no loan term.  Your monthly payment is calculated based on a percentage of the balance.  Normally between 2 and 4%.

Example:  You have a credit card balance of $5,000 with an interest rate of 18% and a minimum payment due each month of 2.5% of the balance.  Let’s run some figures.

Month 1:  Using the evil credit card equation, your first payment due is for $125.  $62.50 goes to interest and $62.50 goes towards the balance.  So your new balance is $4937.50.

Month 2:  Using the evil credit card calculator, your second payment is $123.44.  $61.72 goes to interest and $61.72 goes towards the balance.

Wait!  Last month, it was $125.  Now it’s $123.44.  What happened?  I’m glad you asked.  The credit card companies only charge a percentage of the balance (2.5%).  As your balance goes down, your monthly payment goes down.

Take a look at what else happened.  The amount of money you paid towards interest decreased.  Month 1, it was $62.50 and Month 2, it was $61.72.  Every month, less and less is applied towards the balance.

If we run the equation all the way to a balance of zero, look at the results over time.

Yes, that’s correct.  Two hundred and fifty months to pay off this credit card.  That’s 20 years.  If you sum up the interest, that’s $4974.  Nearly the same amount you started with.

For those who are still reading . . .

The secret to eliminating your credit card debt is NOT to pay the minimum due.  Rather pay the same amount each month.

Using the same numbers as before, Month 1 payment is $125.  We are going to change the rules and pay $125 for Month 2, Month 3, etc etc etc.  If we run the equation until the balance equals zero, look at the difference.

Paid off the same amount of debt but only within 50 months.  Not 250.  And you can see the reason why.  Each month, the amount you apply towards the principle is actually increasing.  Not decreasing.  Total interest paid is only $1,974, for a difference of $3,000.

What’s the secret?

If you act now, because we can’t do this all day, you can know the secret of clearing debt for only $99.99!

Just kidding.  There is no secret.  What you need to do is change the rules of the game.  Don’t accept your credit card companies repayment plan.  Substitute your own.  Pay the exact same amount each month.

One last graph, comparing the balance between minimum monthly payments and steady payments.  The results speak for themselves.

No, I’m not sadistic nor am I certifiably crazy.  Tax season means one thing:  tax refund.  Who doesn’t like that?

Let me state that when you have investment property, you should also have a tax professional prepare your taxes.  My guy costs $300.  The return on this, usually between $4,000 and $5,000, is well worth it.

Preparing for tax season need not be complicated.  I’m going to present you with my system, which has served me well over the years.  Relax: no expensive software to buy nor is this a sales pitch.  Actually this entire system is free.  Maybe 5 minutes of your time each month.

Spreadsheets

Google offers users free access to their online spreadsheet program.  This has been my best weapon at organizing all these expenses.  As we all know, each spreadsheet is broken down into tabs.  Each tab can be used for a single property.  (See Diagram)

The first section:  Rent.  Each month, I track when the check arrived and which unit paid.  Since I keep a photocopy of each rent check, I don’t write in check numbers.  Keep it simple.  

Section Section:  Repairs and Maintenance.  The water heater breaks or the toilet requires snaking; whatever is broken is catalogued here along with how much it cost to fix and the date.  The receipt from the store or the contractor is kept in my 2008 Expense folder.  And the guys who come once a week to cut your grass?  That counts too.  Yard maintenance is key.

Third Section:  Upgrades.  Did you have the property repainted?  How about installing a new screen door?  Those particular items aren’t repairs and qualify as upgrades.  Your accountant decides which because repairs qualify as tax deductions today.  Upgrades qualify as deductions upon the sale of the property.

At the bottom of each section is the SUM function, which turns everything into one number.  Print this tab and take it with you to your accountant.

Overlooked deductions

Any publication such as Barrons or Investor Daily can be a deduction.  Your membership to the Landlord Association?  Yep.  Do you blog about real estate?  Another deduction coming up!

Remember that one time, at band camp, when you had to buy a snake for the toilet?  Those 15 miles you drove to Lowes counts at $0.35 per mile.  That’s $5.25 and round trip, that means $11.50 you can write off.  Make sure to log the date and time in your spreadsheet along with the mileage.

Your prefer Quicken to all this spreadsheet mumbo jumbo?  The $70 is deductible.  Now that your computer is involved, that probably gets to be depreciated as a business asset.  How does that sound?

Target Number

The more money you can attribute to your investment, the more you’ll get back in your refund.  The standard rule of thumb is 40 cents back on the dollar.  Let’s say that with all the repairs, maintenance, and other deductions you can write off $1,000.  That means you’ll get $400 back just on that part alone.  This doesn’t even consider the interest paid on the mortgage not the depreciation of the property.  Your accountant can take care of that.

Oh, and the $350 I pay the accountant?  Yep, that is deductible too.  I’ll get roughly $140 back.

In case the listing is missing, let’s sum it up.

1. Asking Price:  $219,900
2. Rental:  $600 per unit ($2400 total)
3. Utilities:  Included with Rent
4. Fully Rented

Just by looking at the preliminary numbers, I was excited to have found a property that would cashflow.  With a mortgage payment of about $1300, the other expenses would be easily taken care of by the remaining $1100.

Then I noticed the taxes were listed.  $7,148.  This breaks down to $545 per month.

An expense of $545 per month will kill this as a potential investment property.  Running the numbers in the Business Modeler verifies this (Scenario 1).

The only way this property would make sense is if the sellers came down $50,000 on the asking price.  Is that realistic?  One could argue that it never hurts to try.  But $219,900 is not out of line with other properties for sale in the same area.  From there, it’s a question of motivation by the sellers.  Just how bad do they want to get rid of this property?

The big elephant in the room is the taxes.  The $545/month lead weight sinks this deal.

Conclusion:

This property was dismissed not because of poor construction or bad neighborhoods.  But rather the deal doesn’t work because taxes moved it out of the possibility category.

Skip this one.  Time to hunt for another.

Feedback from our popular iPhone software, "Buy That Duplex Pro", has been astounding and full of great suggestions.  One suggestion that keeps coming up is that the software needs a new name.

So, we created the New Name iPod Nano Contest!

Interested?  Get started NOW!

Competition ends February 20th, 2009.

Regular articles to resume next month.

Have a great weekend!

Some investors recommend condominiums as investments due in part to their relative cheapness.  Compared to buying a single-family home (SFH) or even a duplex, condominiums are cheaper.  Are they really the better vehicle for investing?

Pros

Condos are typically cheaper to purchase than Single Family Homes (SFH).  The biggest difference: a yard.  Banks just love a property that stands on it’s own, surrounded by grass.

But that leads into the second benefit which is there isn’t a yard to maintain.  The exterior of the actual condo is the responsibility of the Home Owners Association (HOA).  They make sure the grass is cut, the pools are maintained, any public buildings are clean.

If anything public is affected and needs repaired, the HOA pays for it.  For instance, if you and several other units experienced blocked plumbing, the HOA would have the plumber come out and fix the problem.  Who pays the bill?  The HOA does using your monthly fees.

As a rental unit, HOA fees are tax deductible.  If not all then a portion certainly is.

Cons

No private yard usually translates into lower rents.  Tenants do like to store things on the property.  Broken down car, dog house, meth-lab and usually they are willing to pay a premium for it.  Because of this, condos typically rent less than a SFH would.

As the house market fluctuates, condos are typically the hardest hit.  When a market correction occurs, condos are the first to lose value and the last to recover.  

Read the HOA agreement carefully.  Several points:

-  HOA fees can be increased year over year without membership voting.  Either by a small percentage or a flat fee.  Build this into your business model.
-  Associations can decide if condos are used as rentals or not.  They may decide to screen your tenants and give final approval.  You’d have no say in the matter.
-  Special Assessment will become two words you’ll hate to hear.  The HOA may decide to install flamingo pink vinyl fences around the property.  YOU have to pay for it out of pocket.

Choosing not to pay HOA fees or the Special Assessment may result in your property being confiscated or liens being placed against your property.  A lien on your condo is a fast way to bring your investing career to a screaming halt.  Your library card may even be revoked.

Summary

This is not to scare you from considering condominiums as a rental income machine.  Many investors do it and are quite please with the results.  Before jumping in, make sure to review the HOA agreements thoroughly along with your other documents during escrow.  It is critical to ensure you are purchasing an asset, which will put money into your pocket rather than a money pit.

Extra Credit: More HOA Horror Stories

Here are some tips to protect your cashflow from being eaten away by minor maintenance.

Tip #1:  Gift Cards.  With Christmas and the holidays approaching, what better way for your family to tell you they love you than with gift cards from Lowes or Home Depot.  People may snicker at the idea but when you’re bleeding money each month the gift card concept sounds better all the time.  Birthdays and anniversaries are also good times for gift cards.

So unless you really want that pink bunny suit from Aunt Mildred, play the guilt card and get your family into the gift card spirit.

Tip #2:  Coupons.  Still think that coupons are for little old ladies trying to save a dime on canned corn?  Lose that notion.  The next time you jump into your car to go to Lowes or Home Depot, print out a coupon for 10% off your purchase.  If you have to replace that shower head, might as well save some money while doing it.  Also using coupons make those gift cards from Aunt Mildred last that much longer.

Where to get coupons?

Change of Address:  Every time you fill out a change of address card, a thick package of coupons arrive at your new address.  Use them all!

eBay:  Yes, everything is for sale.  People sell packs of coupons on eBay for $10 or less.  Buy from someone reputable and make sure your coupons have bar codes on them.  I got burned once because my coupons were barcodeless.

Google:  Go to Google and type in "Lowes Coupon" or "Lowes Online Coupon" and watch the sites appear.  Most sites have links that allow you to directly print out a coupon to take.  Other sites may require that a coupon be mailed to you.

Tip #3:  Videos.  Watching videos can save you money?  Face it: you watch YouTube at work.  Stop watching NInja Cat and  learn something useful.

Your tenant’s toilet is clogged.  You worked that plunger until the bathroom floor was covered in water.  Nothing.  Before calling the $80 plumber, watch a video instead.  Just because one technique didn’t work doesn’t mean another one won’t.

This happened to me.  When the plunger refused to remove the clog, I almost called a plumber,  Dreading the $80 service call and watching a butt-crack, I found a video talking about a plumber’s Auger.  Spending $7 on an Auger sounded more appealing that an $80 plumber butt-crack so I did it.  It worked.  Good thing to because a month later, the toilet got clogged again.  Come to find out, the water pressure isn’t the greatest and it will require an occasional Auger to clear it. 

Do you think a plumber should share that information with me?  Each time I call, I’m handing him $80 for five easy minutes of work.  I’d rather not.

At the end of the day, every investor wants to keep their cashflow coming.  The higher the cashflow, the better.  Don’t let trivial problems eat away at your money.  One day, when you have dozens of rental units, your handyman can worry about those repairs.  But until that point, don’t be afraid of a little elbow grease.

November’s analysis is being posted a week early.  Next week I’ll be off, eating delicious turkey and stuffing for Thanksgiving.

Today I venture into Southern California.  A condo is listed at $133,000.  In case the ad is missing by the time this goes to print, here are the stats.

• An REO property in Long Beach, California
• Three bedroom, 1 bath at 994 square feet
• Covered, Gated Parking

To use the business modeler, we need the asking price and rent.  No rent is listed so I’m going to use rentometer.com.  For this neighborhood, RentoMeter.com tells me that $2000/month is a decent price for rent.  Yes, it’s true I could go higher.  But I want to be conservative with my estimates.

Using the business modeler, Scenario 1 shows a cashflow of $248/month. 

A few comments about Scenario 1:

• This doesn’t include HOA fees.
• Room for negotiation

A real estate agent I know also runs a Property Management (PM) company in Long Beach.  He says that in Long Beach PM companies charge 5%.  Not 10%.

I’ll rerun the modeler using the following changes:

• Asking Price reduced to $123,000
• Property Management at 7% (figure conservative)
• Other increased to 20% (for HOA fees).

Scenario 2 shows a cashflow of $182 per month.

Is this the best investment vehicle for our money?

Just because we’ve achieved positive cashflow doesn’t mean that real estate is the best investing vehicle.  If you put $50,000 into a property and only get $100/month in cashflow, that is an ROI (Return on Investment) of 2.4%.  You would be better off putting the $50,000 into a tax free municipal bond at 5% which would provide $208/month.

Verifying the cashflow from a bond or money market account is straight forward.  Use the down-payment of $12,300 at 5% and divide by 12 months.  Cashflow is $51.25 per month.  Significantly less than our $182 per month.

Another quick method: figure out the return on this property and compare it to the bond’s ROI.  Take the monthly cashflow and multiply by 12 months then divide by the initial investment.  $182/month x 12 months divided by $12,300 produces a return of 17.7%.

Looks good.

Pitfalls

This property works if:

1. Asking price is reduced
2. Rent is $2000/month
3. HOA fees are about $200. 
4. The condition of the condo doesn’t require major renovations.

It’s very realistic the agent would accept a $10,000 drop in the price.  The property has already been written off the banks’ books.  Negotiation may not be difficult.

Rent is contingent on neighborhood.  If the neighborhood isn’t desirable, neither will the rent.

HOA fees were assumed at $200/month.  Is this accurate?.

True the property is REO.  But since properties must be livable in order to be financed, we can assume the basics of the condo are in decent shape: such as electricity and plumbing.  Will the carpet have to be replaced?  Are all the appliances present and accounted for?

Summary

With the cashflow at $182/month and an ROI of 17.7%, the property warrants further investigation.  

Steph happens.

Steph is a Real Estate Wholesaler based out of Florida.  She finds distressed, foreclosed properties and then flips them over to investors.  Recently she obtained an $18,000 investment property for an investor, with rental income of $750/month (approx $400/month in cashflow).  Can you say Cha-ching?

Without further delay, let’s start the interview.

BTD:  We hear on the news that states like Florida and California are being hit hard with this real estate mess.  From your standpoint, how is the wholesale business in Florida doing?

Steph:  My wholesale business is booming right now!  The market is flooded with short sale properties and REOs, and many buyers are unable to get financing due to the credit crunch.  These factors are steadily driving prices down and resulting in an incredible buying opportunity for landlords and rehabbers who are looking to scoop up some serious bargains. Many of the investors I am selling to have been patiently waiting for an opportunity like this to come around (again), and are buying up deals left and right.  To give you an example- the last deal I sold was a 2 bedroom 1 bath 900 square foot bungalow, needing about $10,000 in repairs.  In today’s market, it would probably appraise for $65,000-$70,000.  I sold it to a landlord for $23,000, and he plans to rent it out for $650-$700/month. 

BTD:  How do Investors typically find you?

Steph:  I do a lot of networking, and a lot of advertising.  I put ads up on Craigslist almost every day, and also put signs up around the houses I have for sale. I also try to attend as many investor meetings as I can so I can pass out business cards as well as flyers advertising the deals I am selling.  Many of the investors I am working with now are repeat customers- they keep coming back because I bring them good deals.  It’s a win-win situation. 

BTD:  What is some of the criteria that investors give you for finding properties?

Steph:  Most of the investors I am working with right now are buy and hold guys/gals, so they are looking for positive cash flow, first and foremost.  Some of them only buy in certain areas, while others will go anywhere as long as the deal is good.  Most prefer concrete block construction, and will pay a little more for block homes than they will for frame homes. 

BTD:  If an investor were to contact you for the first time, saying "Hey Steph, I want to get the ball rolling.  What do I need to do to make this happen?"  What would you tell them?

Steph:  Just give me a call or shoot me an email, and we can go from there.  Once I get a clear picture of what type of deals you are looking for, I will contact you when I have something that fits your criteria.  We will also need to discuss how you will be financing the properties. 

BTD:   What are some of the key items investors do, or fail to do, that allows a deal to fall apart?

Steph:  I have had a pretty good success rate in getting my deals to the closing table.  The deals that have gone South have been the result of the buyer’s financing falling through. Most of the investors I am selling to now are cash buyers, which makes the whole process run a lot smoother. 

BTD:  If someone weren’t interested in investing in Florida, what resources are available to help them find a wholesaler in another state?

Steph:  I would start with Craigslist.org- many wholesalers that I know post their deals on CL.  You could also put up your own ad on Craigslist (in the real estate services section) saying that you are looking for a good wholesaler to work with.

Real estate investor meetings are also a great place to network and find wholesalers in your area.  Here in Tampa, there are several meetings throughout the week, and there is always a good mix of real estate professionals in attendance.  Check your newspaper classifieds, as well as online classifieds (Craigslist), to find a REIA near you.

BTD:  Steph, thank you so much for taking time out of you busy schedule to  chat with us.  We’re looking forward to your continued success.

You can keep up with Steph and her adventures on her site Flip This Wholesaler.