Real Estate 042: Picking an Investment Strategy

Everyone is different. We come from different backgrounds, jobs, financial status, and most importantly, we have different goals. As mentioned previously, part of getting educated in real estate is clearly defining your goals and creating a strategy to achieve those goals. This is a very important step because a ship without a clear direction, is basically sailing towards nowhere. Note: As you continue to read books, network with investors, and listen to podcasts, your strategy, tolerance for risk, and method of execution may evolve, and that is perfectly fine.

There are a couple different strategies that I have seen that are used by investors on BiggerPockets and other successful real estate investors that you may have come across on Youtube or HGTV:

Wholesaling

There are many people who are getting educated on real estate but give lack of money as an excuse for not getting started. Brandon Turner, Co-Host of the BiggerPockets podcast, summed it up perfectly: "To succeed in real estate, you only need to have two of three things: Time, Money, or Knowledge." Wholesaling will require time and knowledge. Wholesaling real estate basically means placing a distressed (needs TLC or major rehab) property under contract and re-selling the property to another investor. You may have seen signs in your neighborhood that say "we buy homes, all cash". These are your wholesalers who typically purchase homes in cash, lines of credit, or other private funds. Wholesalers are not in the business of buying property, but to quickly re-sell them to investors for a profit (aka finders fee).  A good wholesaler will maintain an active buyers list and purchase homes that are in the buyer lists criteria and re-sell them prior to closing on the original contract. 

For example, let's say there is a house in Independence, MO that you put under contract for 30K. If the home has a repair budget of 25K and after repair value (ARV) of 80K, an investor may be willing to purchase the home for 35-40K. In this example, you would quickly sell the contract to the investor for 35-40K and profit 5-10K on this single transaction. Wholesaling is a great way to build your seed money if you are looking to expand into flipping properties or purchase buy and holds for rental income.

Flipping

Flipping real estate properties is a method of purchasing distressed properties (bankruptcy, foreclosure, REO), adding value through rehabs, and selling them for a retail profit. You may have been exposed to flipping on hit HGTV shows such as flip or flop, masters of flip, or brother vs brother. Normally, these investors purchase the properties from wholesalers, courthouse steps (foreclosures), or from banks for cash and "force appreciation" of the home through value add rehabs such as new kitchen, bath, backyard, rooms, paint, HVAC, etc. 

Using the example above, the flipper may purchase the distressed property for 35K and put in rehabs of 15K for an "all-in" cash of 50K into the project, and sell it for 80-90K (market value) for a 30-40K profit. This method is riskier than wholesaling and buy and hold due to the high usage of capital and the risk of properties not selling quickly in a downturn market.  Further, there is also a large risk of miscalculating the rehab costs that can quickly exceed the ARV, in which case the project is no longer profitable.

For example, the flipper buys the home for 35K with an estimated rehab of 15K. However, during construction, it is identified that the foundation needs work (10K), and HVAC needs to be replaced (5K) on top of the original estimate. Now the flipper has an addition 15K of unforseen costs for an all-in cash of 65K into the project. Their profit on this deal has now been cut in half.

Buy and Hold

This is my current strategy of working with real estate investments and if done correctly, this can be the most passive form to generate income and overall wealth. There are normally 5 different steps for this strategy, but you will notice that you don't have to be actively involved in all 5 steps. Like Tim Ferris emphasized in his book "4 hour workweek" you can outsource these steps, at a price, of course. Take a look below and decide the opportunity cost for yourself:

1. Pre-Approval/Financing: 
This is a key step in the real estate investing process. There are many ways to finance a deal: Savings (from W2, Wholesaling, Flipping), Private Loans, Syndications, Partnerships, FHA, or conventional financing (most common). If you are going the conventional financing route, it is important to be pre-approved with a lender who works with investors AND the market that you are investing in. Just because they are in that market, doesn't mean they have experience with the nuances with working with out-of-state investors, nor does working with investors mean they understand the market that becomes more important during the underwriting/appraisal process.

Pre approval is critical because as a buyer, you want to know your exact buying power, so that when you make an offer, the seller knows it is solid. You might wonder why the lender is asking for many documents such as tax returns, bank statements, etc. simply for a "pre-approval". However, this will eventually save you time in the back-end as these same docs will not have to be re-submitted.

2. Acquisition:  
You have many options when it comes to purchasing a property. You can find a realtor to represent you in the market you are analyzing (they have access to the MLS, and good realtors have built a network to obtain "off-market" deals, often at a discount), you can work with a "turn-key" company (more information below), or work directly with the owner/seller's agent to negotiate on sites such as Zillow, Redfin, Trulia, etc. I would highly recommend working with a buyer's agent as their commissions are paid by the seller and they can give you objective third party advice at no additional cost - more protection for you (note: some buyer's agent may have a broker's commision -  a fixed fee paid by the buyer, and other fees that will be disclosed to you prior to working together).

There are many subcategories to acquisitions: Neighborhood Class, Cash Flow, CapEx/Rehab, Cap Rate/Cash on Cash, Type of Property, Choosing a Market. I will discuss all of these in a separate post.

3. Rehab: 
Rehabbing might be fun for some, but a bag of worries for another investor. In my experience overseeing the rehab of my parent's primary residence, rehabs always tend to take longer than expected, and cost more than expected. If you are the type of person to loss sleep when you uncover unexpected costs or delays during a rehab, I would recommend you outsource this step to another party (i.e. TurnKey). However, if you want to build "sweat equity" and realize savings through your own rehabs or by using a licensed contractor, make sure you do your research and create an accurate budget with room (10-15%) for contingencies. Network with other investors in the local market from BiggerPockets, Real Estate Investor Association (REIA), or Facebook Groups and obtain recommendation for contractors with a solid track record and interview them thoroughly. I have heard too many horror stories on contractors running away with investor money, or providing pictures of rehabs of different houses, only to have the investor make a surprise visit and see that not everything was done as promised. I want to re-emphasize the importance of getting yourself educated so that you know how to ask the right questions and make judgments for yourself instead of relying solely on other people's advice. Remember, no one has your interests in mind like YOU.

4. Management/Maintenance: 
You will often hear that "investors live and die by their property manager". I think this is no doubt 100% true. The sales/acquisition/rehab/financing is only 5-10% of the overall picture. 90-95% of the time you will be working with the property manager to make sure that your investment is being properly tenanted and maintenances being performed.

You can manage your own properties if you are local, however, if you are investing out-of-state, this will be near impossible. Typically a property manager will request 8-12% of the monthly rental income. A couple key benefits for outsourcing property management is: 1) Not needing to respond to maintenance inquiries at all hours of the night/weekends 2) Not having to perform marketing for leases/screen tenants 3) Not having to perform timely bookkeeping/accounting records for tax purposes. I believe the 8-12% is well worth the above services. There are a ton of bad property managers, but there are good ones as well. Make sure you fully vet the property managers just as you would vet the realtor, turn-key company, or contractor. 

Final Thoughts

I will leave you with this final note. One of my favorite speakers/authors Tony Robbins said this: "The defining factor is not the lack of resources, it's your lack of resourcefulness that stops you from taking action" – Tony Robbins.

Whether you decide to wholesale, flip, or buy and hold, make sure that these strategies are aligned with your goals (building capital, or monthly cash flow). Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

Real Estate 008: BRRRR method of investing

In my previous posts, I have discussed different strategies to meet your real estate investing goals. I have recently come across a method that has been popularized by Brandon Turner at BiggerPockets.com but has existed and been used by savvy real estate investors who want to start investing using little to no money down. So what is it? The BRRRR method - stands for Buy, Rehab, Rent, Refinance, and Repeat. Lets take a closer look at each step below:

1. Buy

They say you make money in real estate in three ways: 1) buy 2) sell 3) cash flow. Knowing your numbers used in your BRRRR strategy is just as important as wholesaling, flipping, or buy and hold rentals. The main focus of the BRRRR strategy is to pull out all your money (in some cases, you may be able to pull out more than what you've put in) and end up with a cash flowing property with some equity. A general rule of thumb is to look for a purchase price that is 75% of the after repair value of the property.

For example: A home that has an after repair value of $150,000 * 75% (cash out refinance) - $25,000 est. rehab costs = $87,500 maximum purchase price.

If you are able to purchase below $87,500 or perform a quality rehab for under $25,000, then you will end up with more equity/less cash out of pocket. Note that the above calculation is a simple illustration and there are usually refinancing costs involved with the lender.

2. Rehab

The rehab budget is always an area of discussion among investors for many reasons. Here are my thoughts on the dollar amount on spent rehab and value add upgrades:

• There is a key distinction between primary residence (Owner Occupied) and rental properties (Leased). Simply put, renters may not need, nor would they pay the extra $25-50/month in rent to have all the bells and whistles that you would want for yourself. Granted, if there are two homes in a neighborhood with all things being equal and 1 has granite countertops/backsplash and the other has none, it may be more appealing and rent out faster. However, you have to decide for yourself, at what cost? For me, I am mostly focused on replacing key CapEx items with little useful life to reduce deferred maintenance as well as making the house livable and suitable for the market/neighborhood (an A class neighborhood will definitely have different upgrades than a C class neighborhood).

• You also have to decide what value add upgrades - new kitchen/new bath/new flooring will being the most return on investment. This is a great conversation with your property manager and rehab crew as they will have the most insight into the neighborhood and experience dealing with tenants.

3. Rent

The next key step is renting out the property after it has been properly rehabbed. Whether you decide to buy and hold or sell the property as "turn-key" alternative, renting the property will help you obtain refinancing with the lender. You can advertise and rent out the property by yourself, or I would personally recommend using a property manager who typically charge 8-12% of the rental income. Their marketing efforts, tenant screening, and maintenance handling should be well worth their fees. Make sure to received referrals from active investors in the market and interview multiple property managers. Remember, a good PM can make a good deal into a solid deal, whereas a bad PM can turn a solid deal into a horrible deal.

4. Refinance

You have crunched the numbers, bought/rehabbed/rented the property, so now you are ready to refinance and pull out your cash (downpayment + rehab costs). Depending on the lender, there will be different seasoning requirements. A traditional refinance may require a 12 month period for which you will have to maintain the property then request a refinance. However, there are many portfolio lenders who have 6 month seasoning requirements or some who can start the refinance process the day after closing (zero seasoning). The lender will order their own appraiser to go to the property and draft an appraisal. 

In the example mentioned earlier, lets look at two scenarios with the same expected ARV of $150,000.

Example 1: Purchase price of $50,000 (bought distressed/foreclosed/divorce/REO) and put in $25,000 amount of repairs for an all in cost of $75,000. The bank appraises it for $140,000. You request a cash out refinance and the bank gives you $105,000 (75% of the appraised value). Now you can fully pay off the $50,000 loan and $25,000 rehab costs (if you used private financing or hard money lender) and have $30,000 in excess cash + 25% in equity.

Example 2: Purchase price of $75,000 (normal sale) and put in $20,000 worth of repairs for an all in cost of $95,000. The bank appraises it for $135,000. The bank does not allow for refinances greater than your all in cost. In this case, you will get back $95,000 to pay off the $75,000 purchase and $20,000 in rehab, and the remaining amount will be left in equity ($135-95K = $40K/135K = 30%).

5. Repeat

The above examples are cases of success stories in which you were able to cash out your initial investment and maintain equity of 25% or greater in the home. Now you will rinse and repeat the process and scale your rental portfolio!

Few thoughts on BRRRR vs. TurnKey/buying off MLS

Although I have bought my first rental property from a turnkey company, I eventually want to try the BRRRR method for a couple reasons: 

• Ability to cash out refinance and retain equity in the home

• Control over the type/quality/amount of rehab

• Ability to retain your "seed" capital for other investments (typical buy will lock up 20-25% cash each time you by, thereby significantly lowering your buying power)

• Allows for faster scaling of your rental portfolio

• Higher return on investment (more of other people's money = higher ROI)

However, there are also a couple reasons why I do not want to jump on the BRRRR bandwagon just yet:

• More risk is placed on the project owner overall (you are buying/rehabbing/renting/refinancing)

• Risk of appraisal coming in lower than expected (not being able to break even)

• Risk of rehab delays (A turnkey is already rehabbed and tenanted)

• Longer process than buying turnkey/MLS

• Risk of being unable to cash out refinance

  • Seasoning requirements

The BRRRR method has been a very popular method for investors to increase their return on investment as well as overall net worth due to the fact that they are leveraging other people's money and if done correctly, able to repeat the process over and over. However, if it was so easy, why doesn't everyone do it? As mentioned in the reasons above, the BRRRR takes careful planning, finding the right deals, using the right team, and comes with its own set of headaches as things can go wrong during the process. What is your strategy? I would love to hear your thoughts on BRRRR vs buying turnkey/MLS.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!

Real Estate 006: Finding the Right Market

In my previous posts, I have discussed why I personally like to invest in real estate and talked about how to get educated before diving in. If you have decided that real estate investing may be right for your financial goals, next up would be finding the right market.

Before even zoning in on one market or another, there are key terms that you must understand: Cyclical and Linear type markets.

Cyclical markets are markets that have large fluctuations in housing prices during a bear and bull market. Its the high risk, high rewards market primarily found on the coastal regions: West (Seattle, Oregon, San Francisco, Los Angeles, San Diego) and East (New York, Boston, New Jersey). Investors in these markets will not likely target cash flow as rent to value ratios using the 1% test will be hard to find (ex: $500,000 home in Los Angeles will not rent for $5,000, it may rent for $2,500-3,000, which is a 0.5-0.6% rent to value ratio). Instead, investors in these markets will play the appreciation game, hoping for large gains in housing prices sometimes 15-30% greater than houses in the MidWest, or linear markets. 

Linear markets, on the other hand, are markets that do not typically see large fluctuations in housing during a housing boom, but do not significantly drop during the recession/correction like the Coastal Markets of California, San Francisco, and New York. These markets are primarily centered in the MidWest (Kansas City, Memphis, Texas, Alabama, Ohio, Indianapolis). Although they may not appreciate as much as cyclical markets, they will be able to have higher rent to value ratios and provide better cash on cash returns for an investor. 

There are many ways to analyze a market, but here are some of the criteria that I look for when researching a new market.

Location Location Location

You may have heard the "L" word more than once. I think this is true still to this day. There is a reason why companies such as Costco, Starbucks, and McDonalds spend hundreds of thousands of dollars analyzing data and the demographics of a neighborhood before opening a location. They know that good location is the key to success. Investors in neighborhoods have realized the "Starbucks effect" has fueled home appreciation in past years. Although it is impossible to guess if these specific areas will appreciate and develop better than other areas without these retailers, but you can make reasonable assumptions and mitigate risk. There are several factors that impact location: Population, Jobs, and Crime.

1. Population

There are many online resources for you to research data in a given market. I personally use www.neighborhoodscout.com, www.bestplaces.net and www.city-data.com to see trends in population growth and demographics (i.e. population by age, gender, marital and education status). Simply put, if a market is seeing negative population growth, it means people are moving out, and housing demand will drop, thereby resulting in lower rental rates and more vacancy. Furthermore, if there is a trend of an aging population or less families, it may also result in renters downsizing sq ft of their home and decreasing demand of standard 3-5 bedroom single family homes that may traditionally be rented to larger families.

2. Job Quantity and Economic Diversity

When looking at jobs in a given market, it is important to not only look at the number of jobs available, projected growth, but also economic diversity. Take a look at Detroit Michigan, for example, which heavily relied on success of the auto manufacturing industry that dominated the area. When those industries suffered and jobs were cut, housing demand and rental prices dropped more than other markets as people looked to move out to other states. States such as Kansas City, MO or Indianapolis, IN that had a well-balanced economy such as retail, manufacturing, transportation, healthcare, and education, suffered less dips in housing and rental prices. 

Do some research on the web to see if there are fortune 500 company presence in the market, are there contracts signed to open new fulfillment centers, new HQ by Amazon? In real estate, its not insider trading, its using information to make good judgment and decisions and capitalizing on trends and forecasts. More jobs also mean more people with steady income to pay rent and other bills.

3. Crime Stats

This is an obvious one, but something that investors may overlook when blinded by a "discounted" purchase price or home that they have fell in love with. Generally speaking, investors with properties in higher crime areas, may be starting off with higher returns on paper due to lower purchase price, and other factors, however, in the long run, you may end up with a lower quality tenant pool, more occurences of vandalism, and even loss of equity because home prices are negatively being affected. I personally use Trulia's crime heat map: https://www.trulia.com/real_estate/Los_Angeles-California/crime/ (Example of Los Angeles) and perform a detailed review of the property neighborhood and crime statistics, along with felons/sex offenders who may be present. This will also affect rent prices down the road.

Crime Stats are related to neighborhood class: A, B, C, but its also made up of other factors such as ratio of owners/renters and good school districts. With that being said, Crime stats should be carefully evaluated to make sure that you are not taking in too much undue risk.

4. County and City Taxes

Taxes are also an important part of your return on investment calculation. Depending on the region, there are different tax rates applied to your property. For example, there are regions in Memphis, TN that charge both a county and city tax: $685 and $550, and there are zip codes 10 minutes away that may only have county taxes $685. In this example, there is a huge difference of $550/year or $46/month per unit that can change a good investment into a homerun.

On the other hand, there are situations where your property may share the same street, but different zip codes that end up costing hundreds in additional taxes. For example, I was analyzing two rental properties in Kansas City and noticed the same company remodeled it, same age, number of rooms, sq ft, but one was $2K cheaper. Taking a deeper look, I realized that one had property taxes of $1,400 while the other had $450 because the county lines were drawn on the same street. Its important to factor in these information when calculating your pro-formas.

Please make sure you do your due diligence and talk to your CPA/Attorney/Financial Advisor before making any investment decision. 

Good Luck!