Two Average Joes has just added two more properties to it portfolio with the close of Dallas escrow.  We purchase two properties from one owner who wrapped both properties in one loan for us.  It was a total of 59 units split between 33 units at Top Flight and 26 at Star properties.

The upside on these properties is occupancy.  The owner was done with the property and did not want to put any more money.  So there were units that were vacant.  There were leaks in several properties that needed to be done but the owner was not going to put more money in to deferred maintenance.  These are opportunities for us.  Another unique the aspect to this properties is an existing storage room.  It is very large and can be converted into two units (2 bdrm and 1 bdrm).  This is additional source of income that will add value to the property.

We purchase this property on a wrap of the existing loans on the properties.  We also split the down payment and over two years.  A zero interest loan for up to 2 years.  A great way to spread you cash over time and use it to purchase properties at a lower price.

Physical: Once the financials have been checked and the legal review is complete it is time for the physical inspection.  You want to do this after the financial because why waste time and money to inspect the proeprty if the seller has been less than truthful about the financial records.  I have cancel many a deal once I have seen the books and the seller did not want to renegotiate the sale.  The physical inspection is much more that you looking at the property.  You will need to spend money on a 3rd party professional inspector.  Don’t try to cut corners and eliminate this step or try to do it your self.  You want an independent eye looking at the property.

• Site inspection: A qualified inspector will preform an inspection that looks over not only the visible elements of the buildings, roof, siding & stairs of the building, but will also look over accessibility.  Electrical & HVAC aspects of the buildings.  Condition of the parking lot & walk-way are an often overlooked aspect part of the property, but these items can be a large expense to replace.
• Property plans and specifications: Do not count on getting these unless you are buying class A or B building.  Class C buildings are often neglected and older buildings.  The older the less likely the owner has the plans. Inspect if there have been nay additions to the original building and did they have a permit.
• Survey: A survey tells you where the buildings are on the proeprty in relationship to the proeprty lines and to each other.  This is required if you have a lender, but is often not done with owner financing unless you ask for it.  Make sure the seller provides this survey.
• Tools and supply inventory: You are not just buying the property and the building but everything used on the property that is stored there.  That means all the tools, equipment, office, etc.  Include everything in the purchase.
• Appraisal:  This is required and ordered by the lender.  But if you are buying from a seller that is providing the financing you will have to take care of this.
• Phase I/Phase II Inspections: This is a more in-depth inspection that will look for hazardous waste.  If it is found, a Level II inspection will be required.  These inspections are expensive and are required whenever a lender is involved in the deal.
• Pest inspection:This is an inspection that you should always have done.  We are mainly concerned with termites but there are other pests.

Though you will have qualified 3rd party inspectors doing these inspection you still want to tag along if possible.  You will learn signs that will tell you of problems or potential problems. It will add to your experience.

photo credit: ralphpaglia

As with anything in life there is a learning curve.  Real Estate Mentors can shorten that learning curve tremendously.  Even really bad mentors can help propel your career along.  Let me tell you have had some real losers as well as some winners.  I am not making any moral judgement of these so-called Gurus, nor do I blame them.  The ultimate responsibility of anything I do is on me.  They are losers not for the information they impart but on the information they don’t impart.  Let go through our early list and I will explain.

1. Robert Allen: a good mentor.  Our contact with Mr Allen in the early part of our career was basically though his book Buying Real Estate Nothing Down.  Had some great ideas but implementation was difficult for the novice.  We were not ready to do all the strategies that he laid out in his book at this stage of our career.  Anything outside of our comfort zone was not done.  We will visit Mr Allen in later posts.
2. Dave Del Dotto:  His program “Cash Flow System” was a begin loser. Everything was easy.  But a lot of his book and system hinge on taking from the seller or down right lying to get financing from the federal government, i.e.getting farm loans from Farmer Home Administration by having a farmer front for you.  Can you say felony and he put it in writing.  We quickly moved on from him.
3. Dante Perano: Dante was a local boy making it in the real estate seminar arena.  He started the Financial Services of America.  This was basically a real estate company that found low priced rental property in other states and sold him to investors who signed up with him.  Good concept but the break down is alway on buying them low enough for the investor to make a profit on them.  Also location, location, location still govern in real estate.  So yes you could buy a property in Hobbs New Mexico for $5,000 but who lives there and where is the property located.  Who are your tenants and what will they pay.  Can you trust the property manager.  Hard to tell when you never meet them.
4. Charles Giverns: I will have a separate post on Mr Givens in our saga, but for now we encounter Givens in are revamp of our financial world and he soon separate to include real estate.  Of all the early guru’s he had the complete package.  I look back and I can see an early form of todays bootcamps.  Books, tapes, newsletter and video tapes.  He started on a small step of the buying process and lead the top coaching program.

Yes we had some losers and winners in our early years but we learned a little piece of the real estate investing market.  It is all these pieces that make us what we are today.  It is hard to admit that we read and followed some of these and others that do not rate mentioning here, but we learned from each one.  Even if it was what not to do.

Avoiding discrimination is imperative when you own investment rental property. The Fair Housing Act regulates this and you could find yourself in legal trouble if you do not adhere to these regulations.

First, you must make sure that the property is available to be shown to all individuals who are interested in renting it. Generally, interested parties will call to inquire about the property before they actually see it. When you answer questions about the property you must make sure that you are providing the same information to everyone who calls. If you venture into offering different conditions, terms and/or information to different individuals who call to inquire about the property, you could be liable for discrimination. Basically, you need to make sure that you are covering all of the specifics of the property without necessarily trying to deter applicants away from the property based on any of the areas which are protected under the Fair Housing Act. Areas which need to be covered when applicants call include amenities of the property, property size, location, etc.

In addition, you need to make sure that your rental application is also designed with fair housing standards in mind. The best way to do this is to have an attorney review your rental application and then provide the same documents to all prospective renters. Also, make sure that the process is the same for everyone. Ultimately, when you deny or accept a rental application your decision should be based on valid requirements and not personal opinions.

Different laws regarding occupancy standards and restricts apply in different states. The key in most states is to ensure that you are using good reason and common sense. For example, if you have a 1,000 square foot two bedroom home, then it would obviously be excessive to have seven people in the home.

There are no prohibitions regarding restrictions on the number of people who are allowed to occupy a residence under the Federal Fair Housing Act. It is critical; however, that any restrictions which are adopted be reasonable and apply to all occupants. You must discriminate on the basis of race, color, national origin, family status, gender, religion or handicap.

The most common standard adopted by most property managers is two people per bedroom. This standard is considered to be fair and reasonable by most. If; however, the residence in question is particularly large or it could easily accommodate more persons, it is important to keep in mind that such a policy could be challenged and a complaint filed so it is imperative to be sure that standards are flexible when the need calls for it based on available space within the dwelling.

Due diligence is a critical part of the buying process.  You should not take it lightly.  While the period can last 30 to 60 days, the time flies fast.  In this second part of three posts we will look at the Financial Review.  Click Financial Review to see the first post.

Legal:  This part of the Due Diligence that is usually handle by other parties to the deal.  Either by your attorney or the Title company.  You will review the following:

• Title:  Review the title of the property.
• Building code violations:  Check for building code violation.  Once the property is yours any code violations will be yours also.
• Zoning certificates:  This should be a slam dunk but check the zoning.  Is the building zoned for the use that it is being sold for.
• Insurance:  Check the insurance coverage.  This ties back into the financials and the expenses you factor into your operating expenses and ultimate the profit of the property.  Also look for the coverage, premium, expiration.  Check the insurance against another company.
• Rental ordinances:   Are there any restrictions on you raising rents on the proeprty.  It most rural and suburban areas this will not be a problem.  it is in the cities that there may be rent control or restriction.
• Licenses, certificates of occupancy and other permits:  Check the assessors description of the property against the actual.  Were any improvements done without a permit.  If the assessor states the property is 45 units and the property is being sold as 50 units – that raises a red flag and you need to confirm with the seller of the proeprty.
• Vendor contracts:  Review all the vendor contracts to see what you are agreeing with.  Most will need to be redone when you buy the property with on major exception, laundry services.  Check this contract carefully.  The seller can enter into an agreement that ties the future owners into a crappy deal.  What happens on these contract is a laundry service will sing the agreement with the previous owner and receive a upfront payment on future earnings.  This can be up to $25,000.  The laundry service is going to recoup this amount over a ten year contract.  They are going to take a significant part of the laundry revenue.  The contract stays with the property not the owner.
• Estoppels:  Are forms that verify what the seller has told you.  You confirm from each tenant what they pay for rent and what deposits they paid.  You can compare the residence’s knowledge with what the seller has told about the residences.

This is a very tedious & sometimes expensive if you are having a lawyer help you, but important part of the Due Diligence of your purchase of a multifamily property.  Spend the time needed to get the information to make an informed decision.

photo credit: TheTruthAbout...

Last week’s post, Our Real Estate Book: The Beginning, I talked about our start in real estate.  It started in Phoenix, AZ.  A disclaimer first: I will be talking about a real estate agent that helped us in buying property in AZ.  He really help us throw our money away.  I acknowledge and accept that it is our responsibility in making the decisions.  Our tale does not diminish the importance and the valuable help most real estate professionals can provide.  Our story is about one particular realtor and is not indicative of all of them.

We will not mention names – mainly ours – to protect the innocent (us) from our wives.  Our Arizona realtor helped us in all faucets of buying property in Arizona.  He was always getting us information on the property and the paperwork we needed to make the bids.  After we purchased (2) properties we went to Arizona to look at our purchases, he was there to pick us up and drive us around like we were two high rollers.  We felt like kings and we believed every word out of his month like it was gospel.  I don’t think we ever questioned what he said until after our forth purchase.  Why? Because he was right.

He told us the price that the VA would accept for the house.  Never mind that is was probably $20K higher than any of the other investors bidding on the houses.  I mean I look back at how naive we were to think that we could roll into town and bid on four house and get them and not think we were bidding too high.  But our realtor just told us that we were doing great.

It was some three months later that we purchased our 4th house, that had not rented, that we suspected that the value of the houses did not match the bids we were offering.  We had four houses in Arizona that were in great shape.  No rehab was needed, but they would not rent for the price we needed to rent them for to cover our costs – let alone make a positive cash flow.  The negative cash flow was a drain on our limited resources.

We eventually did eventually rent the houses out, but that is a whole another story, for less than the mortgage payment but at least we did not have to make the entire payment out our pocket.  So each month we supplemented the mortgage pay that the rent would not cover.  That is not a good situation to be in.  After 12 months of trying to make it work we eventually sold the properties on a short sale to another investor and we exited the Arizona market.  A valuable lesson learned is do your own research.  Trust but Verify!!

photo credit: jimmiehomeschoolmom

I have been asked many times how I analyze multifamily properties.  I thought I would go through my steps in today’s post.  The idea is to look at many properties quickly to determine which one warrant your further attention.  I have created a spreadsheet that I use to do my analysis.  This spreadsheet will organize all rents, expenses, additional income to determine the Net Operating Income.  From here you can determine Annual Debt Service, Down Payments, Reserve Accounts, Private Money requirement and the highest we will pay for a property.  Here are the steps

1. Find the property – Loopnet or broker
2. Determine the unit mix and rents for each – from broker
3. Potential Rental Income (# of units x monthly rents x 12 months) (PRI)
4. reduce total by vacancy and credit loss = Effective Gross Income (EGI)
5. Add other income from laundry, etc = Gross Scheduled Income (GSI)
6. Subtract Operating Expenses (OE) to get Net Operating Income (NOI)
7. From NOI you can determine what you want to pay for the property by dividing your CAP Rate
8. If this price if more than 20% less than the asking price I will file the property away for a few months
9. If it is within 20% of the asking price I will continue with the analysis
10. Does the property need rehab and estimate that amount
11. Determine the Annual Debt Service, Reserve Account, Private Money needed to close and the rate of return offered to the private lender

I can go through this analysis in 10 minutes and I know if we have a property worth our time.

photo credit: word_dancer51

Due diligence is a critical part of the buying process.  You should not take it lightly.  While the period can last 30 to 60 days, the time flies fast.  In this first part of three posts we will look at the Financial Review.

Financial: You want to look at every part of the property’s financials.  You should request and receive the following documents:

• Past 2 years of monthly operating statements:  You have based your purchase price on numbers that you may have gotten from the broker for the seller.  You want to review the numbers each month so you can look for trends in the expenses of the property.  This history is valuable in giving you a glimpse of the management of the property.
• Year-to-date operating statements:  While history is good but we want to look at how the property is presently  operating.
• Rent roll for current and past two years:  Like the review for the expenses you want to look at your income side of the property.  Again you are looking at trends in the property.  The past shows the trends, while the current rent roll will confirm your numbers that you based the purchase price on.  It all comes down to money in and money out.
• Past three months deposits:  While somethings can be faked – like names on a rent roll – deposits in a bank account cannot.
• Existing loan documents:  You should be aware of the term of the existing loan.  This is especially important if you buy the property with a seller wrap.
• Security Deposit:  Verify the deposits.  This is important because this money will be credited to you at close of escrow and thus reducing the money you need for closing.
• Utility bills:  This is verifying elements of the operating expenses.
• Property tax bills:  This is a major expense that you want to review.  Verify the last assessed value.  If the price you are paying is higher – your tax bill will be higher.
• Service Contracts:  You want to verify all contracts with the property.  One that is critical and needs to be verified is the laundry contract if you have a laundry service.  These are contracts outlast the sale of the contract.  Look at the terms closely.  These contract frequently give the owner of the property a large payout on the front and very little during the contract.
• Payroll register:  Confirm what the staff is being paid.

These documents and information confirm the financial viability of the property.  This is the first review of the Due Diligence because this this is the first that is will fail.  Saving further time and travel expenses.  If your assumptions do not meet with reality, then cancel the deal and more on.

photo credit: TheTruthAbout..

Our real estate journey has been filled with pot holes especially the early days.  My brother Jeff and I have for years talked about writing a book with our experiences.  The subject usually comes up after we have had to our come some challenge or obstacle.  I think it is time we stop talking about it and start writing it.  I’m going to use my Monday posts each week to chronicle our experiences over the last 20+ years in real estate.  I will try to keep them in  some kind of order as we go through our memories.

The beginning: My brother and I started our real estate career after attending Charles Given’s Real Estate Seminar.  It was a 3 day seminar in Sacramento that we attended.  We finished the seminar and declared ourselves real estate investors.  We set out to begin our career – part time.  I was an architect working at a firm in San Francisco.  My brother was working with my father as a manufacturer’s rep selling bar equipment.  So we were researching and buying real estate part time.

1986 – 89: One of my favorite movies, Ferris Bueller’s Day Off, was in theaters, the bears beat the Patriots in the Super Bowl and the Tax Reform Act of 1986 has passed and is being implemented.  The tax reform eliminated real estate as a tax shelter.  All investors, both professional and amateur  alike, lost their tax shelters overnight.  Investors who were happy taking losses on their properties because it lowered their taxes were no longer allowed that deduction.  Thousands of investors were holding properties that had negative cash flow were left with no benefit to holding them.  Investors started losing their properties or started dumping properties.  This led to, of course I am being simplistic, the Savings and Loan Crisis.

It was in this environment that we stated our career, 1989.  We started looking at foreclosed properties in California and Arizona.  That led us to VA foreclosures.  The Veteran’s Administration was a major holder of foreclosed properties in Arizona.  We started our research with these properties.  By research I do not mean an exhaustive study of the market forces that made the Phoenix market such a hot bed of foreclosures.  We looked the price of homes in the area and compared them to the only area we really knew and that was our backyard.  In our neck of the woods, houses that were 700 square feet were selling for $125,000.  A fortune in those days.  In Arizona we saw properties that were 3/2 and 1400 square feet selling for $80,000.

Our first purchase was a VA foreclosure in Phoenix Arizona.  How the VA sold properties were by sealed bids.  You researched the property and  decided what to bid for the property.  If you were the highest bidder you got the house.  They had an inspection period where you could go and look at the property, but not being from Phoenix we did go look at it.  Your bid had to go through a realtor so we asked our realtor to tell us about the property.  He was GREAT – I saw that with sarcasm.  Of course he thought the houses were great.  Just a little conflict of interest since he got a commission for every house we bought.  He would help us establish the price for the houses we bid on.

We bid on four houses in a period of three months and what do you know we got everyone.  Jeff and I were amazed that we could do bid so well.  Our realtor said that there was little competition for these houses we were bidding on.  It was later that we realized that we had bid too much.

Our first purchase was a 3 bedroom, 2 bath, 1400 sq ft house in a Phoenix , AZ that was built in 1986.  We bid $80,800 dollars and won the bid.  We thought we had a great deal.  A 3 bedroom/2 bath house for $80,800 compared to the $125,000 shack we had in California was an awesome deal.  Trouble was this house was not in California – it was in Arizona and it was surrounded by hundreds of foreclosures that were worth a lot less.  The biggest mistake is that it took a few months to figure out our problem.

I’ll leave that for next time.

photo credit: Wesley Fryer

If you are like most investors of multifamily properties, you tend to take on everything yourself to make sure it gets done and done right.  That is a recipe  for disaster.  You need to delegate to survive.  Just get the thought in your head and get use to it.  You can’t do everything.  You need to attract quality people to you to help your growing concern.  There are a number of things you do before you buy a property, but that number multiples by a factor of ten after you buy a property.  All those deals will kill you if you take them on yourself.  Here are some strategies to help you.

1. Procedures: You need procedures in your office to handle questions as they come up.  This makes for a consistent response to everyday challenges.  This is along and laborious task, but when complete you can give the procedures to someone in the office and you are reasonably assured that the tasks will get done like you want them to get done.
2. Interns: Hire an intern.  There are hundreds of college students that would kill to get an inside look at how an investor work his real estate business.  You can find good quality interns at any university.  Do not expect them to hand around unless you are willing to compensate them well.  These are very bright and intelligent students who are looking at your opportunity to learn the business and apply it themselves.
3. Virtual Assistants: These are businesses setup to handle work that does not require a physical presence in the office.  It is a great way to get help very quickly.  You will probably have to commit to a set hours per week or month.  Procedures are a must when working with someone not in your office.  There is a learning curve to the service.
4. Hire staff: This is last on my list because I had to lay-off 6 people in this economy in my other business and it is not fun.  I will make sure that I have more than enough work before I expand my staff.  The biggest plus to this step is you have the most control over your workload and can be the most fulfilling.

So there are 4 steps to reduce your workload and keep you sane.  You should do what you do best and let someone else help you with the things they do best.  If you have any other ideas drop me a comment.