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193 pages, Paperback
First published September 1, 2004
CHAPTER 1 THE MYTHS AND THE MAGIC
Myth 1 You Have to be already wealthy to invest in real estate
Partners “help you spread your risk by allowing you to own smaller positions in a number of properties rather than a big position in just one.”
Myth 2 You need to start small – big deals are too risky
Some of the reasons why large properties are not riskier:
1 “Mortgages on smaller properties like single-family homes are almost always guaranteed through the buyer’s own personal earning potential and wealth… Larger investment property loans are secured by the asset itself.”
2 Appreciation of small properties depends on the appreciation of the surrounding neighborhood while appreciation in commercial properties is based on the cash flow of the property itself.
3 Your exposure related to occupancy is reduced the more residents you have.
Myth 3 You can “flip” your way to success or get rich quick with no money down
Flipping is dangerous and no money down means that the property is 100 percent financed, which means more expenses with little or nothing left for you to improve the cash flow. In this way you depend on appreciation as well to make money. “Appreciation is only in your control when you have improved cash flow.”
“Buying and holding income-generating assets like rental properties is how you build wealth.”
Myth 4 Some people just have the Midas Touch
Myth 5 You need a great deal of confidence
Myth 6 You want to do it but do not really have the time
Myth 7 You have to know somebody to get going in this business
Myth 8 You have to be a seasoned negotiator and business person
The listing price is meaningless because it is the seller’s opinion of what the property is worth. So negotiating based on it is time wasting. Evaluate the property based on operational performance and not on the sale price.
Myth 9 You have to know a lot about real estate
Myth 10 You cannot be afraid of failing
Myth 11 You have to know the tricks of the trade
CHAPTER 2 YOU GOTTA HAVE A GOAL
A goal is something you plan to achieve, should be measurable (in time, earnings), and should be attainable and realistic. Make yourself accountable to somebody. Have a partner who will encourage you.
What you do after setting your goal is important:
1 Communicate your goal clearly. Tell people about your goal.
2 Plan and set milestones.
3 Persevere and drive thorough all obstacles
Keep you focus and discipline. Do not let opportunities divert you from your goal.
CHAPTER 3 IT TAKES A TEAM
The following qualities are required in partnership:
1 Healthy debate: You should have room for debate before decisions are made
2 Open-mindedness: You should not have to spend valuable time continually convincing your partner of your goals
3 Commitment: You should be committed to each other and your goals
4 Similar values: You and your partner should share the same values
5 Accountability: You and your partner should push each other to achieve objectives and have mutual accountability
You do not need all of your team members at all times. Your team members are:
3 Real estate broker
4 Property manager
5 Lender or mortgage broker
7 Contractor/Rehab specialist
10 Insurance agent
11 Property tax consultant
12 Income tax consultant
13 Estate planner
14 Environmental company/industrial hygienist
16 Structural engineer
CHAPTER 4 RESEARCH CAN BE FUN?
Level One Research. You can do it inside your house. Look at every real estate website and gather information about the economy and employment in the area.
Level Two Research. It is time for face-to-face meetings. Ask for recommendations in these meetings.
Level Three Research. Ask every team referral.
Remember that all the information you will gather in your research is free!
CHAPTER 5 SWAMPLAND FOR SALE
An important lesson from the poor people who have purchased swampland is that “the market is more important than the property.” You should evaluate your market and submarket. Do not rely on instincts when you buy a property. Do your homework and find facts!
Supply and demand is a critical tool to understand the market and submarket in a particular area. Supply is “the number of rental properties available in a market or submarket.” Demand is “the number of people looking to rent.” Ask brokers and property managers to find out these information. Demand has many indicators like:
1 Occupancy rate. High occupancy means great demand and vice versa.
2 Prevalence of move-in incentives and specials. If there are a lot of move-in specials advertised, demand is high.
You should consider future supply as well. Check all new rental property that is in various stages of development, from planning to permitting to construction.
Ideally, supply should be lower than demand. There are three drivers of supply and demand:
1 Employment. Look at the employment and presence of companies as well as employment stability; how stable the employment base is.
2 Population. Even a great deal is meaningless if nobody is around to lease it. Employment and town persona are population draws. But watch out for:
1 Resilience. Make sure that the growth of a market or submarket is not too heavily reliant on one thing.
2 Economic Diversity.
3 Pioneering. “Being too far out on the fore front of things can be expensive and dangerous. [The author] tries not to create the wave, simply catch a wave [he] see[s] beginning to build and ride it in.”
4 Affordability. “Look for markets where the cost of home ownership far exceeds the cost of renting.”
3 Location. “Locations have to be evaluated not based on geography alone, but based on how they measure up in relation to supply and demand.” Look for:
1 Great locations have drive-by visibility. The more cars that pass by your property and see your “For Rent” sign, the better your chances of success.
2 Great locations possess a rare quality.
3 Great locations are in demand.
CHAPTER 6 FINDING YOUR DIAMOND IN THE ROUGH
To become an expert, you need to:
1 Use your research about the property and the market.
2 Read everything.
3 Look around. Always look at the neighborhood.
4 Listen more than you talk. But be aware of rumors and verify what you hear.
5 Join a business networking group or trade association.
So after these steps, what do you do when there is no property for sale? Should you change the market? No. Contact owners even if there is no “For Sale” sign!
Ask the owner the rent roll, current occupancy and operating expenses. They are very important.
CHAPTER 7 IS IT REALLY A DIAMOND?
In good deals the numbers work. In bad deals, they do not.
You need to know the following three things:
1 The seller’s asking price is irrelevant
2 You determine the property value, which becomes your offer
3 With multiple units, the property value is based on the current cash flow of the property
The Five-Step Property Valuation
1 Verify property income
Check a pro forma document and rent roll.
There are three types of income to consider with any property:
1 Actual income: The total income the property generated in the prior twelve months
2 Actual potential income: The total income the property could have generated in the prior twelve months had all units been 1—percent occupied and had the owner taken advantage of all other income opportunities
3 Future potential income: The total income the property could generate at today’s market rents, 100 percent occupancy, and taking full advantage of all other income opportunities
Buy based on actual income!
Do not forget vacancies and turnover from residents moving in and out.
2 Verify expenses. Repairs and maintenance, utilizes, real estate taxes, insurance, replacement reserve.
3 Determine net operating income (Income – Expenses)
4 Find the capitalization rate and valuation
Capitalization rate = Net Operating Income / Purchase Price
Property Value and Offer Price = Net Operating Income / Capitalization Rate
5 Calculate the loan payment and your profit or cash on cash
Now you come up with the initial cash flow and arrive at an offer price. This evaluation process does not require a physical inspection. Actually, it happens before it. Physical inspection is important in EVERY case.
CHAPTER 8 THE BIG COMMITMENT
You can make a decision when you know 70 percent of everything there is to know about a property. After the numbers work for you, you need to tie up the property, “and during that time, you negotiate the terms of the sale and, equally as important, review the property and its operations in its finest detail.”
You need whether a letter of intent or a standard purchase and sale agreement.
Letter of Intent. “[It] contains your offer along with the basic deal points like down payment amount, due diligence time frame, escrow amount, and financing contingencies.” During the letter of intent stage the property is not off the market.
Purchase and Sale Agreement. It is after the letter of intent. “This is where you communicate all the specifics of the sale, in other words you list exactly what each party is going to do to complete the deal.” Do not forget the statement: “All units must be rent-ready at close of escrow.”
CHAPTER 9 DUE DILIGENCE: THE EASTER EGG HUNT
During the due diligence phase:
You need to conscientiously review every document pertaining to property operations.
You need to perform thorough walk-throughs of every apartment unit.
You need to pay careful attention to every detail.
You need to be thoughtful about how you can improve the property and cut expenses.
You need to be attentive to the tasks and deliver them on time.
You need to be meticulous in your evaluation and reporting.
It is the time when you make detailed assessments of actual costs for property improvements, ongoing maintenance, and operations.
The Due Diligence Checklist
1 The File Audit
2 The Interior Inspection
3 Government Agency Reviews
4 Service Agreement Review
5 Exterior Inspection
You also need to check the books and records, obtaining information for your operating budget by categorizing the income and expenses. Review the following:
1 Twenty-four months of income and expense statements
2 All service agreements
3 Current rent roll
4 Utility bills
5 Payroll information
CHAPTER 10 MAKING SENSE OF IT ALL
You need a property management plan and an operating budget. “The management plan will define the key strategies you will use to either cut expenses, increase income, or both. The operating budget links numbers to those strategies and helps you quantify your bang for the buck.”
The Operating Budget:
1 Calculate actual potential income and other income such as: Laundry income, parking income, water and sewer income, late fees, nonsufficient funds fees, cable income, internet revenue and telephone income.
2 Calculate expenses such as:
2 Administrative. Fees paid for professional services (an attorney and accountant).
3 Marketing and advertising
4 Management costs
5 Repair and maintenance costs
6 Property taxes
9 Capital repairs
CHAPTER 11 You Own it… Now What?
Property manager should do the following:
1 Solving problems daily
2 Handling staffing issues
3 Leasing the property
4 Increasing the cash flow
5 Legal and contracts
7 Rent collection
8 Paying the bills
9 Managing the budget
11 Customer service
If you want to hire a property management company, ask them about the following:
1 Property management fees
2 Time in business
3 Accounting software and capabilities
5 Policies and procedures
6 Professional affiliations and associations
7 Training programs
8 Real estate licenses
9 Legal and background checks
10 Vendor negotiations
When to fire your property manager:
1 When the property does not perform well as anticipated
2 When the property does not improve its operations year to year
3 When the property really outperforms expectations because management is easy and a management company is not needed
Mistakes you should avoid:
1 Renting to the wrong person
2 Not taking care of your current residents
3 Not budgeting for the unexpected
CHAPTER 12 To Sell or Not to Sell
When you want to sell your property, you need to:
1 Maximize your future potential income. Make your rental rates at the market rate in the area, even at the expense of occupancy. Unlike when you are buying, when you sell “you want to demonstrate the highest future potential income for the property, not the highest actual income.”
2 Running your expenses lean