Real Estate 013: Pros and Cons of Section 8 Rentals

When placing a tenant in your newly rehabbed or purchased rental property, finding a suitable candidate may often depend on various factors such as neighborhood, schools, type of home (single family, duplex, bedroom/bath count), and time of year (winter vs spring). The US government has a housing assistance program called “Section 8” that is funded by the Federal government but administered by the local authorities. This may present an opportunity for real estate investors to tap into a different kind of pool of tenants. Potential candidates for Section 8 assistance must submit an application and become accepted into the program. Typically these spots are reserved for low income families, disabled persons, and/or senior citizens. As a landlord, you can legally choose to participate or not participate in the Section 8 program. As I have two Section 8 properties, I wanted to share with you my experience with the program and dispel some myths:

Advantages of Section 8

1. Tenant Pool

By choosing to accept Section 8 applicants, you are “widening the net” to include both market rate tenants and Section 8 applicants with vouchers. This will allow you to be more selective in your tenant placement and technically have more candidates that meet your pre-defined criteria.

2. Guaranteed Monthly Income & Higher Rent Rates

One of my favorite parts about participating in the Section 8 program is that a portion of the rents (70-80% average for my rentals) is being paid on the 1st of each month by the Government. As long as the tenants do not lose their voucher or you, as the landlord, do not fail multiple Section 8 inspections, you should be receiving these checks via ACH like clockwork.

Further, as the Government determines the appropriate rent range in a given market for the type of house (3 bedroom 1 bath $750-850 vs 4 bedroom 2 bath $900-1,050), the landlord is able to select the higher rate of the range as long as the tenant has the voucher to support the rent (3 bedroom vouchers vs 4 bedroom vouchers).

3. Lower Vacancy

Tenant turnover is one of the single biggest expense an investor faces. When your property sits vacant, it generates no income, but there are many fixed expenses such as the mortgage, taxes, and other fees that occur monthly. Based on conversations with other investors who have done Section 8 for 10+ years, if the Section 8 tenant is happy with the property and landlord, they will stay put for a longer time than their market rent counterparts who often move more frequently for their children’s schooling, new job opportunities, and to find a larger home/purchase their residence.

Disadvantages of Section 8

1. Section 8 Inspections

On an annual basis, you are required to undergo a Section 8 inspection with the housing authority’s designee. This may cause you to make some rehabs sooner than later if the inspector feels that updates need be made immediately. There is not cost involved for the landlord (other than your property manager potentially charging you for their time to meet the inspection and perform the updates).

My take: I personally feel that having an annual inspection at no charge is a benefit for real estate investors as it forces me to take a look at my property and ensure everything is up to code, there is an liability exposure, and preventive maintenance items are taken care of. As the inspector is not looking to make cosmetic improvements, but make sure the property is functionally sound, it serves as an additional line of defense.

2. Wider selection, but “rougher” tenants?

Generally speaking, it appears to be widely accepted by real estate investors that Section 8 tenants are rougher on the homes and cause more wear and tear on their properties. This idea stems from the fact that since they are receiving assistance, and not pouring all of their own hard earned cash into the rent, they have less skin in the game to care about what happens to the property.

My take: I think that regardless of market tenant, or Section 8, you still need to do your due diligence and be thorough in your tenant selection process. Contrarily, as tenants may lose their voucher if they cause excess damage than normal wear and tear, and as Government funding gets tighter, Section 8 tenants will think twice before “trashing a property” that they live in. I’ve had B class market rate tenants trash a unit, and also had C class Section 8 tenants who were very clean and left my property in great condition.

3. Dealing w/ a Government Agency

As this is a Government program, you will have to work with local authorities when issues arise and that may mean time lost. Some counties are notorious for not responding to an email for weeks and taking up to two or three months to setup a new tenant in the system for payout. However, all strategies have their pros and cons, risk and rewards. As for Section 8, after it has been initially setup, it has been on autopilot, and I have received the Government’s ACH and tenants money order every month without issues along with an addition $100-200 what I would have received with a market rent rate tenant.

In conclusion, I think there are different strokes for different folks and some may not see the benefit of working with Section 8 tenants. I personally feel like in the markets which I invest in have a great Section 8 tenant pool, with above market rents that will allow me to cash flow a minimum 5% higher with little to no additional risk. Furthermore, on a personal level, it gives me a sense of pride that I am providing a roof over the heads of those who need it most: senior citizens, disabled persons, and/or low-income families.

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

Good luck!

Real Estate 012: 4 traits of successful real estate investors

For real estate investors who have recently taken the plunge and picked up rental properties, its very easy to be excited about this new venture and idea of financial freedom. My personal method of achieving success in anything I do is first seek out mentors and experienced investors who may have walked down a similar path, had failures, but overcame them to reach their goals. This way, I shorten the distance between a new and experienced real estate investor and also can save myself from costly mistakes. Below are 4 traits of successful real estate investors that I have met throughout my journey:

1. Continuous education

Knowledge is a powerful tool. Brandon Turner, Host of the BiggerPockets podcast frequently says, “you need multiple tools in your toolbelt to meet the needs of different problems that you will encounter as a real estate investor. To an investor who only has a hammer, every problem will appear to be a nail.” You will often hear from other investors that real estate is simply about solving other people’s problems. Whether it be buying a rental from a seller going through personal life issues, financial struggles, or a wholesaler who is looking to unload/assign their rights to a property, or an investor with a great deal but needs capital or a partner to walk them through the process. If you continue to educate yourself in this field you can become more creative with deals (e.g. seller financing, subject-to, land contracts, BRRRR, commercial financing, partnerships, syndication). Do your due diligence and become your own best adviser.

2. Maintain control of your investments

One thing that I really appreciate about real estate is that it is tangible, easy to understand, and you have control of your decisions. Prior to investing in real estate, I invested in stocks and bonds for over 7 years, and although I knew how to read financial statements, proformas, and general fee structure. I never once remember who my portfolio manager was, how exactly they are being paid and incentivized to take care of my hard earned cash. Nor did I understand the detail behind market fundamentals that drove a stock price up and down. As a direct real estate investor, I get to control who I work with in terms of acquisitions (e.g brokers, wholesalers, agents), rehabs (e.g. contractors), property managers, and lenders and the buck stops with me. These people have been coined the “core 4” by investor David Greene (check out his book “Long distance real estate investing” for more valuable information on investing out of state). Once I have my core 4 in place, you have more control in terms of running your numbers to fit your cash on cash criteria, as well as getting creative to create even more equity or cash flow (e.g. adding an extra bedroom or bath, going section 8 in certain markets, etc.)

3. Invest with the end in mind

A prudent investor will set goals and stick to his/her predefined criteria. Of course, you are free to update your criteria as markets change and you gain more knowledge into the subject matter at hand. However, do not get “trigger happy” and fudge the numbers to take down a deal. If you start compromising (e.g. 14% CoC → 9% CoC as this house is “well rehabbed”), it will become a slippery slope and you may find yourself holding a bag of loser rental properties that are difficult to unload in a downward market. Real estate is a long game, so think of your exit strategies whether it be 1031 exchanging into bigger, nicer neighborhoods, getting into multifamily apartments or private lending, you want to understand what you are purchasing instead of going for quantity in the short run. In other words, be a prudent, long-term value investor, never a get-rich-quick gambler, speculator, or flipper. Invest only in properties that make good financial sense the day you buy them.

4. Use leverage to create wealth

Many successful investors will tell you the one word that build them their wealth: leverage. Leverage can come in many forms such as other people’s money (e.g. banks, private lenders, hard money lenders), other people’s time (e.g. wholesalers, brokers, contractors), and lastly, other people’s knowledge (e.g. partners, mentors). You may run into student’s of Dave Ramsey’s teachings who proclaim debt is bad and you should make purchases all cash. However, this advice, while safe, is not going to get you to financial freedom anytime soon. There is a reason why Dave’s teachings focus on saving your first $1K, creating reserves, debt snowball methods, and budgeting to create a better financial future. I agree the aforementioned strategies are important if you are heavily drowning in consumer debt. The debt I am referring to relates to good debt, which is used to create assets that positively cash flow. There is a difference between a person who has $5k on their credit card from purchasing clothing, jewelry, and the latest electronics and pay a minimum balance with 22.58% interest vs an investor who obtains a 80K loan at 6% interest amortized of 30 years for a rental property in the midwest that cash flows $350/month after all expenses and debt payment.

I personally have debt on my personal residence as well as my 10 other rental properties. However, my 10 rental properties all cash flow positive a minimum of $200/unit and my primary residence was used to obtain a HELOC (home equity line of credit) that creates even more cash flow through the use of leverage. By simply using leverage, I have been able to add $100K to my net worth during the past year and this is all through use of other people’s time, money, and knowledge. Let other people’s money work for you, reduce your risk, and make you wealthy.

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

Good luck!

Real Estate 011: Cash Flow Analysis and Market Research

Cash Flow Analysis and Market Research

When people ask me how I can invest thousands of miles away in the midwest while living in California, I tell them that your confidence build the more research you do on your markets as well as your local team on the ground. That is why I started to build my own team after purchasing a couple turnkey houses. Mainly, a realtor (who gets paid when you close a deal) is going to see a project differently from a contractor (who gets paid by the amount of work performed) and that will be entirely different from a property manager’s perspective (who gets paid by the amount of income it produces) By looking at a property and its market through the lens of a team who all have different opinions, you will get a better view of the whole picture.

Here is the recommendation I received from a local property manager when I was starting to research my market:

1. Using an Agent/Realtor

If you are buying a property through the MLS, have your realtor go out to the property and take photos/videos. Ensure that they get pictures of the roof, mechanicals, foundation, and plumbing/electrical systems. These will make a bigger impact on your investment as a new roof and furnace doesn't necessarily demand a higher rent rate but it may lead to loss of tenants and in turn, revenue for your business. These capital expenses don't usually have much impact on the rent rate, so if they need to be updated, you want to ensure that it's figured in the rehab budget. Unless you are doing a full gut-rehab, I always recommend getting a home inspection and having a General Contractor walk through the property as well. Your realtor should be able to coordinate these activities.

2. Researching the area

How is the crime? Is the school system a factor in vacancy? What conveniences and amenities are nearby? Are there any industrial areas nearby (landfills, recycling facilities, wastewater treatment facilities, train tracks, air ports, prisons re-entry program, etc.?) Is it in a flood zone (High insurance deductibles)? Are there problematic homes in the immediate vicinity (boarded up homes, illegal dumping, abandoned cars, unkept yards, etc.?). These potential issues should be communicated by your agent and/or property manager who are your local boots on the ground.

3) Tenanted Properties

If the home you wish to purchase is tenanted, make sure to get copies of the leases and rent rolls. What are the tenants paying? When does their lease end? Are they current? How much is being held in a security deposit? Is the security deposit going to be rendered to the buyer at closing? Newbie investors may think that “cash flowing on day one” is an advantage, but note you may be paying a premium to take on someone else’s problem. Buying a vacant property allows you to have your trusted/vetted PM place a qualified tenant, even though that may mean your property sits vacant for a month or two, and will be paying a lease up fee.

4) Proforma vs Actuals

Most of the time, an agent or the seller may provide you with a proforma, or estimated cash flow the buyer may expect to see with the purchase of the property. Based on my experience, these numbers are optimistic at best. Ensure that you get market rent rates from both the realtor and property manager (This information can also be cross referenced to websites like Zillow, hotpads and Rentometer). Frequently, realtors are not as accurate with their rental information unless they work heavily in that space, where as property managers should always have the most current data based on their experience and inventory.

You will also want to understand property taxes, HOA fees, and get an idea of insurance costs. Your realtor should be able to help with this as well and a good insurance company should be able to assist with the insurance costs (Obtain an actual quote).

After verifying against the location criteria, understanding the scope of any rehab and having a budget built, and getting a good understanding of the probable rent rate, you plug these new numbers in the original underwriting you did with assumptions and see if it fits the original plan. If it doesn't, negotiate the deal to better fit the criteria that you set up in advance.

Here's a checklist to help assist your research:

• Get opinions on specific location. Crime, School, Flood zone, Specifics to that location?

• Get market rates to determine ARV / Fair Market Value. In some markets you will want retail prices and as-is, distressed prices if investing in areas with lots of rehabs. A realtor should be able to provide a broker’s price opinion (BPO) or Comparative Market Analysis (CMA), sometimes for a fee.

• Understand the property taxes, HOA fees, property management fees, and insurance costs.

• Get rent rates for the location, size, amenities, condition, time of year, etc.

• Get a home inspection and have a General Contractor (GC) build a rehab budget.

• Verify tenant information (if tenanted).

Plug all of that data that you obtained yourself into your calculations and see if it still performs against your criteria. Do not fudge the numbers to make it work because you want to close. The only thing worse than no deal is a bad deal that loses money. Don't take a bad deal because you are eager, ensure that it's a deal and get a third party to help you put an eye on it.

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!