2 Things Multifamily Real Estate Investors
Need to Know About the New Tax Law
On December 22nd, 2017, President Trump signed the Tax Cuts and Jobs Acts of 2017 into law. This piece of legislation represents the most comprehensive overhaul of the tax code in 31 years.
The new tax law, which takes effect this year, is complicated and sprawling. There are a number of aspects that still need to be tweaked, and 100% of the tax implications aren’t entirely clear. Still, for the most part, it looks like commercial multifamily real estate investors stand to win big with the new law.
Today, I want to talk about 2 of the most exciting tax changes for commercial multifamily investors. Before I do, though, I highly recommend you pick up the phone and call your accountant. As I said, there are a number of complexities in the new law. Your best bet would be to have a qualified professional look at your specific situation before you go making significant changes to your business and/or tax strategy.
Corporate Tax Cuts and Pass-Through Deductions
The first important change to affect multifamily investors isn’t specific to real estate. Instead, it deals particularly with corporate taxation. Most savvy real estate investors, however, opt to structure their investment business as a corporation, partnership, or LLC. Here’s a link to a video I did explaining the different businesses structures for multifamily investors. Even if you’re an unstructured sole proprietor, there’s something in the new tax law for you.
The most notable and controversial (depending on your political perspective) feature of the new tax law is the corporate tax rate’s massive cut from 35% to 21%. This cut applies strictly to C Corps. However, to maintain balance with S Corps, Partnerships, Sole Proprietorships, and LLCs, the law also includes a 20% deduction for “qualified business income.” In other words, if your business functions as a “pass-through,” then you’re likely to realize a significant discount on your 2018 tax bill next January.
Keep in mind, “qualified business income” is one of those complicated features of the new law that isn’t so easy to pin down. It includes all ordinary income (minus employee wages). It doesn’t include capital gains or dividend income. Again, this all gets complicated fast, so make sure your accountant is on top of the changes.
“The bottom line is this: if you’re a business owner, your taxes are going down this year.”
Big Changes to Commercial Real Estate Depreciation
The second change comes in the realm of property depreciation. Unfortunately, nonresidential (a.k.a. commercial) property is still depreciated on a 39-year schedule.
Property improvements, on the other hand, are a different story.
Not too long ago, all improvements on commercial property had to be depreciated over the full recovery period of 39 years. Over time, space was carved out in the tax code for immediate expensing of specific physical improvements. In 2015, this was solidified in the PATH Act, which allowed for a set of immediate deductions, shortened depreciation schedules for certain improvements, and bonus depreciation. While this was all great for commercial real estate in general, it didn’t help multifamily property much at all.
Thanks to the new tax law, Section 179 of the Internal Revenue Code—the area that governs these types of deductions—has received a few investor-friendly modifications. Under the new code, the dollar limit on those capital expenses has doubled from $500,000 to $1 million, which is great news for commercial investors in general—but again, what about multifamily owners?
Here’s where the new law gets particularly sweet. Under the old code, the items you could immediately expense were limited to certain kinds of interior improvements to nonresidential, retail, and restaurant spaces. Under the new code, however, that scope has been expanded to include things like new roofs, HVAC systems, fire protection and alarms, security systems, and (potentially) home furnishing.
From a capital expenditure standpoint, this is huge. Instead of depreciating out that new roof, you can immediately expense it and claim it as a deduction. The tax savings on this move immediately make value-add strategies a whole lot more attractive.
To sum this all up, multifamily owners stand to gain significant tax relief from two angles: lowered income tax and increased flexibility with deductions.
We’ll have to keep a close eye on how this affects the market. Will inventory tighten as landlords use their tax relief to hold on to marginally performing properties? Will we see an uptick in value-add investing? Only time will tell.
Join the conversation on our Facebook community page MultifamilyCommunity.com as we watch these developments unfold. Every day, over 10,000 investors gather to pool their expertise and inspire one another to take their business to the next level. We’d love to have you.
Tenant Turnover: Its Costs and What You Can Do to Minimize Them
In the multifamily real estate business, cash flow is king. That means one of a landlord’s highest priorities should be to keep occupancy rates as close to 100% as humanly possible. Anything less than that and cash flow will suffer.
That’s why tenant turnover is a silent killer.
Turnover happens when a tenant decides it’s time to move on and the landlord is left with an empty unit to fill. While this may not seem like a big deal at first, a month or two of lost income per unit, per property can quickly add up to significant vacancy losses.
Here are some of the specific ways in which tenant turnover costs landlords money:
As mentioned above, the most significant cost associated with tenant turnover is lost income. For however long it takes to find a new tenant, the landlord is stuck with an unproductive unit. Vacancy losses of this kind can drastically affect the bottom line.
Cleaning and Repair
Preparing a unit for new renters doesn’t just take time; it costs money as well. A couple hundred dollars spent on deep cleaning, fresh paint, and minor repairs will only intensify the economic pain caused by vacancy loss.
Marketing and Administrative Costs
Thanks to the internet, marketing is cheaper and easier than ever. Still, advertising takes some measure of time, money, and effort. On top of that, “hands-off” landlords will have to pay an on-site manager or agent to show these properties to prospective renters.
When a new renter is found, the landlord will also need to pay for tenant screening, background checks, and a credit report. Once again, this adds to the pain of turnover.
“How You Can Minimize Tenant Turnover”
Of course, there are ways to minimize each of the costs I mentioned above.
- To help with vacancy, you can (and should) line up new renters before your current tenants move out.
- To minimize repair costs, you can exact a healthy security deposit from new tenants and guard it jealously.
- To keep marketing and administrative costs down, you can rely on social media for advertising and find cheaper ways to screen tenants.
Still, each of those measures will only take you so far. If you really want to cut down on these expenses, you’ll need to treat the problem at its source: turnover itself.
That said, here are 5 ways to cut down on tenant turnover:
1. Due Diligence & Market Research
Before anything else, turnover is a function of property location. You can do everything right, but if your property is located near transitional housing in a less-than-desirable part of town, you can expect tenants to roll in and roll out frequently.
Investors can and do make a living serving areas with high turnover, but only because they’ve got the systems and scale to run an incredibly streamlined operation capable of turning over new tenants as quickly as possible.
If that’s not you right now, then focus on stable markets with low vacancy and strong employment prospects. In general, you’ll want to stay away from military towns and other areas that feature highly transient populations.
Caveat: College towns earn an exemption here. Given the regular rhythm of supply and demand, the benefits far outweigh the challenges of turnover—provided you set up the systems to keep turnover time to an absolute minimum.
2. Screen Your Tenants
If you want to hold down tenant turnover, focus on getting the ‘right’ people into your units. Who are the right people? At a minimum, they’re responsible adults with a proven track record of dependability both at home and at work.
To find these people, be sure to screen new applicants on both the financial (work history, income, checking/savings balances, etc.) and behavioral (tenant history, criminal record, etc.) aspects of their lives.
Never trust your gut. Always take the time to do the paperwork and find out exactly who you’re dealing with. You’ll often be surprised at what you find.
3. Offer Lease Incentives
A simple way to reduce turnover is to lock tenants into a longer-term lease. If you can get a renter to commit to 24-months, you’ll all but guarantee yourself two years of stable income with no vacancy loss during that time.
Of course, any lease longer than 12 months represents an added commitment on the renter’s part. They’ll rightly want to be compensated for that. Be prepared, then, to incentivize a longer lease either by way of a minor discount or unit/appliance upgrades.
4. Keep up Regular Maintenance
For a tenant, there’s nothing more frustrating than having your maintenance calls fall on deaf ears. As a landlord, it’s your responsibility to respond promptly to these requests and see to it that everything is in good working order. Not only will this keep your tenants satisfied, but it’ll minimize later expenses due to deferred maintenance.
Maintenance matters outside the unit as well. Your residents need to be able to take pride in the place where they live. They can’t do that if the front door is broken, the hall lights are out, and the common areas look like they haven’t been cleaned up since 1972.
Strive to create an environment people genuinely love to call home, and they’ll be more inclined to stick around at the end of their lease term.
5. Build Relationships
A successful real estate business is built on solid relationships with brokers, lender, other investors and, yes, even your tenants. Minimizing turnover greatly depends on the strength of your connection with your tenants.
This doesn’t mean you have to become best friends with every single one of your tenants. It does, however, mean you have to find intentional ways to create and cultivate these relationships.
This begins with screening and choosing quality people, setting clear expectations at the beginning, and promptly taking care of their needs.
“But, it doesn’t stop there.”
Find ways to go above and beyond for your residents. It may seem hokey, but I’ve known landlords to send out Christmas cards, deliver turkeys on Thanksgiving, and go from door to door handing out buckets of popcorn.
Little actions like this don’t cost you much, but go a long way in helping people want to keep living in a place, if for no other reason than the fact that you’re their landlord.
You won’t be able to prevent all tenant turnover. For 101 reasons you can’t control, people need to move. That’s fine. Don’t worry about the circumstances you can’t control.
Instead, pour your energy into the five areas I mentioned above, and you’ll find your tenant turnover numbers begin to improve dramatically over time.
“Still, sometimes it makes sense to hire a property management company (PMC), especially if you’re new to the business.”
A professional PMC can help you conduct your due diligence on a property and learn how to manage it after you’ve closed.
In today’s post, I want to give you 9 things to look for when hiring a PMC. I’ll do that by walking you through the key questions to ask and what you should hear in response.
To determine whether a PMC can adequately serve your needs, you need to know where their office is located and who in the neighborhood they’re already working with.
How close are they to the property?
Your manager should be visiting the property regularly. To make sure they keep up with that, choose a company that’s located within a reasonable driving distance.
Do they own any multifamily properties near by?
If one of the principles in a PMC owns property near yours, they’ll be inclined to rent their property first. Move on to a company whose interests don’t conflict with yours.
Do they manage similar properties in the area?
Not necessarily a deal-breaker. Just keep in mind that a 200-unit complex down the street will demand more of your manager’s time and attention than your lowly 15-unit.
Keeping your units rented out is imperative to sustaining consistent cash flow. That said, you need to know how your PMC plans to get tenants into our units.
What marketing methods and channels do they use to advertise?
Whatever specific channels they mention, be sure that your property will be advertised on the manager’s website, Facebook, and Craigslist.
Do they have a marketing plan? If so, what does it consist of?
Marketing a rental isn’t exactly rocket-science, but it does take a certain level of strategic intentionality. The PMC should have a plan in place to not only post your property in the relevant online channels but to refresh each one on a regular basis.
What’s their average turn-around time from when a unit is vacated to when it’s rented again?
Time is money; you can’t afford to wait for a slow PMC to “get around” to filling a vacant unit. Make a note of this number so that you compare several managers to one another.
3. Tenant Screening, Applications, and Leasing
You want to fill your property with tenants who respect you, the property, and their neighbors. Tenant screening and leasing are the primary tools a property manager uses to ensure your property brings in nothing but high-quality renters.
What’s their process for screening potential tenants?
At the very least, screening should include a credit report, background check, verification of employment, and a call to the potential tenant’s current and former landlords.
What does their lease look like?
Every lease should include the following:
- Names of every tenant
- Occupancy limits
- Rental term
- Monthly rental rate
- Any deposits and fees
- Repair and maintenance expectations
- Rights of entry
- Noise/activity restrictions
- Pet restrictions and fees
How do they conduct a lease signing?
The lease signing is an important occasion to establish a relationship with new tenants and set expectations. Be sure that your PMC will be willing to use this opportunity to communicate your policies (rent collection, eviction, etc.) with new tenants.
It’ll be your manager’s job to keep up both the physical appearance and the mechanical operation of the property. You need someone you can trust to stay on top of repair needs and get them taken care of in a timely and economical manner.
How do they handle tenant emergencies?
It’s important that you hire a PMC that takes seriously its responsibility to provide a safe, serviceable environment for your tenants. That said, pass on any managers who don’t keep a 24-hour emergency hotline.
How often do they inspect units?
Judging by the age and condition of the property, use your best judgment to decide how often the PMC should look at each unit. What matters most is that they do regular inspections to ensure expenses don’t multiply due to deferred maintenance and neglect.
Who does the repairs?
Either the PMC’s maintenance staff will do repairs, or they will subcontract the work. In either case, make sure repairmen are licensed and insured to cover the scope of the work and that they’re reasonably priced. Maintenance is often a lucrative profit center for managers, so look closely what they intend to charge you for repairs.
5. Rent Collection
A streamlined, meticulous process for rent collection makes for reliable monthly income. Look for a PMC who understands that basic principle.
What’s their procedure for collecting rent?
What’s spelled out in the lease concerning deadlines and late fees? Also, how do they actually collect the funds? A physical check at the office? Online payment? In the case of the latter, find out what fees are involved.
How often do they report rental income?
Some PMCs will offer to send quarterly reports. In my judgment, you should insist on receiving a monthly statement. That way, you can keep a closer eye on operations and address any inconsistencies right away, rather than on a three-month lag.
Don’t make the mistake of sitting back and letting your PMC work on auto-pilot. I know from experience that’s how you set yourself up to be taken advantage of.
What reports do they provide?
Here’s what they should give you:
- Income statement
- Expense statement
- Current rent roll
- List of all vacancies
- List of all delinquencies
- Annual budget
There’s no avoiding it: a property manager is going to cost you. That’s one of the reasons I ultimately advocate for self-management once you have enough of an infrastructure to take it in house. (but only after you stop buying property) You do not want to distract yourself from acquisitions to manage. With a little research and smart shopping, you can keep your management costs down to a reasonable level.
How much do they charge?
A PMC will typically charge around 4-8% of your gross monthly rent. For small properties, however, they may charge upwards of 10%. Shop around to see who can offer the best rate without compromising on value.
Are there any additional leasing fees?
A PMC will often charge a leasing fee when they rent a vacant unit. This fee can range from 50 to 100% of the monthly base rent. Depending on your market, this expense can be passed on to the renter.
“Nobody is perfect. Accidents happen, and mistakes are made. Protect yourself from legal liability by hiring a licensed, insured management company. “
8. Licensing & Insurance
Are they licensed?
Like any other real estate professional, property managers are required by law to carry a license in the state where they operate. Google ‘[your state] real estate license search’ to find your state’s online resource for looking up active licenses.
Do they carry liability and errors & omissions insurance (E&O)?
States also require that property managers carry both liability and E&O insurance. Get your hands on copies of both policies so that you can review them with your lawyer.
Once you’ve satisfied yourself concerning the previous 8 categories, then you’re ready to start talking about contract terms.
Can you see a sample of their contract?
A PMC shouldn’t hesitate to provide you a redacted or sample copy of the contracts they use with existing landlords. Take the time to review that contract with your attorney.
How and when can you cancel the contract?
One of the most important terms to look for is the contract’s cancellation clause. If the PMC fails to do their job, what rights do you have to terminate your agreement? If a manager refuses to make this concession, then move on to the next one.
Is there an exclusive right-to-sell agreement in the contract?
Many PMCs will slip a section into the contract giving them exclusive rights to list your property in the event you choose to sell. Don’t agree to it. Whether you’ve established a relationship with another broker or not, you want to leave your options open for the future—especially, if you can sell the property without using a broker at all.
We’ve gone through quite a bit here. But, when it comes to hiring a property management company, you need to do your due diligence. No other partner will have as direct an impact on your property’s success than its manager.
So, take your time and choose a good one. Your bottom line depends on it.
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What a Landlord Needs to Do to Prepare for Disaster
While I was on vacation in Switzerland in September of this year Florida residents saw the awesome power of nature as Hurricane Irma tore through southern Florida. The strongest of its kind in over 10 years, Irma killed more than 100 people and caused over $60 billion in damage.
“Whenever something like this happens, I’m reminded of how challenging it can be for landlords to secure their tenants and properties in the midst of a crisis.”
- What do you do when an apartment fire wipes out a quarter of your units? How do you get your remaining tenants to safety and who do you call once the smoke clears?
- How do you handle forced evacuation due to a natural gas leak? What’s the quickest way to communicate the issue to everyone who needs to know?
- What do you do when a water pipe bursts on the fourth floor and causes significant damage to each of the apartments below it? Who will you call to do the remediation and how long will those units be out of service?
These types of crisis situations happen every day. Unless we, as landlords, prepare for them in advance, we’ll find ourselves scrambling to cover our bases.
That’s why I have a crisis management plan for every one of my properties. In the event of an emergency, I want my on-site personnel to know what they need to do to ensure the safety of every tenant and the security of the property.
Do you have a crisis management plan in place for your properties? If not, then keep reading as I share what I take to be four crucial elements in preparing your properties for a crisis.
1. Establish a Chain of Command
“When disaster strikes, someone needs to take charge — especially if you’re not close enough to the property to offer direct supervision.”
The first thing you should do in preparing a crisis management plan is to designate an authorized representative to act as your point person on site. He or she can be someone from your property management company or your on-site manager.
In your written plan (see step #3 below), you’ll declare your on-site point person and, from there, delegate further responsibilities to him or her along with any other staff you deem appropriate. When it comes to notifying residents, contacting emergency services, and engaging contractors, you want to make it clear who is expected to do what.
2. Set Up Simple Communication Channels
In the event of an emergency, you need a quick and easy way to get the word out to every tenant. In a smaller building, that may be as simple as sending staff to knock on doors.
In a larger complex, however, that just won’t work. Thankfully, digital technology has given us several ways to reach a large block of people in a short amount of time.
To that end, I’d recommend you set each of your tenants up in a mass texting service like WeText or Textedly. That way, when disaster strikes and you need to get the word out immediately, you can reach everyone without delay.
Once the dust settles and you’re ready to communicate more detailed information, email is a helpful tool. It is not, however, a reliable medium for urgent communication.
3. Develop a Written Plan
You should talk with each of your on-site staff members about their responsibilities in the event of an emergency. Still, you can’t rely on memory or personal judgment to prevail in a crisis. You need a written plan to make sure everyone plays their part.
In your written plan, make sure to highlight your top priorities:
- Safety – Warning your tenants of imminent danger and keeping them out of harm’s way should be at the top of your list.
- Security – Once you’ve ensured the safety of your residents, the property itself and its contents should be secured from further damage or potential theft.
- Settlement – After the tenants are safe and the property is secure, you can begin to call insurance claims adjustors, vendors, contractors, etc.
Include a property-specific evacuation procedure in your written disaster plan. Additionally, provide instructions for sheltering in place in the event of a hurricane, tornado, earthquake, or other natural disasters.
If you’ve hired a property management company, then they should have their own plan in place for these types of situations. Review it with your property manager. If they don’t have one, work with them to develop one as soon as possible.
4. Prepare to Respond to the Media
Whenever a crisis occurs at one of your properties, you can expect the local news media to follow closely behind. Unfortunately, you, as the landlord, can expect to be cast as the villain—regardless of whether or not you’re at fault.
As a rule, instruct your on-site personnel to defer all media requests directly to you. The last thing you want is one of your employees doing an on-air interview with your smoldering apartment building in the background.
Keep in mind that instinct #1 for most journalists today is to sensationalize. Keep your cool and calmly answer whatever questions you’re able to address. Assure reporters that you’re working swiftly to take care of your tenants’ needs.
Note: If there are any questions of legal liability, it would be wise to contact your lawyer before responding to the media.
Unfortunately, disaster strikes from time to time. There’s nothing you or I can do to prevent that. What we can do is prepare ourselves so that, when disaster does come knocking, we can address it with calm and prudence.
If you can learn to handle a crisis with the same diligence and care that you bring to every other aspect of your businesses, you’ll be prepared to weather whatever storm crops up in the future. All it takes is a little forethought and preparation.
“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”
Failure is a powerful teacher. But, as Warren Buffet reminds us in the quote above, it’s much better to learn from other people’s failures so that we don’t repeat their missteps.
That said, here are 7 common mistakes I see in rookie and experienced investors alike:
Not Carefully Building Your Team
Real estate is a people business. Your success greatly depends on who you surround yourself with. To that end, I advocate building yourself a team of competent, reliable professionals to work with on a regular basis.
When you fail to identify the best people to work with, you’ll often find yourself saddled with misinformed real estate brokers, sketchy mortgage lenders, and unscrupulous property managers.
From my own experience and that of other investors I’ve coached, these people can harm your business in a number of ways—from sheer incompetence to willful fraud and embezzlement.
Take your time here. Run your due diligence on the people you work with as well as the properties you buy. Lean on fellow investors and experienced partners in the market to help identify the very best people for your team.
Buying the “Wrong” Properties
Investors often go astray when they wander outside their target market to buy a property they otherwise had no business looking at. This usually happens when a broker or another investor emails over a ‘hot’ opportunity or a ‘sure deal.’
When these kinds of opportunities spring up, FOMO (fear of missing out) will kick in and propel you down the wrong path. Before you know it, you’ll be outside your area of expertise trying to breathe life into a flailing property in a market you don’t understand.
To steer clear of this mistake, you need to develop well-defined investment criteria. Stick as close to your stated goals as possible and let everything else pass by.
Neglecting Due Diligence & Rushing Into a Deal
Properly executing your due diligence takes discipline and time. If you’re going to make sure a property is truly up to speed, you have to be willing to go through the paces of dotting every I and crossing every T.
No matter how promising the deal looks on paper, take the time to see the property in person and run through every step on your due diligence checklist.
If you’re interested in how I do this, join us in the closed Facebook Group MultifamilyCommunity.com and check out my Live video I shot in Kentucky performing due diligence on a 48-unit apartment complex.
Overlooking Economic Vacancy
Evaluating vacancy is a crucial part of your due diligence process. If a property is underperforming, you want to know exactly why so that you can judge whether or not you can improve the situation after closing.
A huge mistake I often see here is when investors evaluate physical vacancy without going on to consider economic vacancy.
To further flesh out how economic vacancy works, consider this example:
You’re looking at a 50-unit complex that rents out at $600 per unit per month. That puts its annual gross potential rent at $360,000. Consider the owner has that property 100% rented out, but they offer a free month’s rent with each year-long lease signing. That drops effective rent collection down by $30,000, which puts economic vacancy at about 8.3%, despite a physical vacancy of 0%. If there are any delinquent rent payments, economic vacancy will drop even further.
Similarly, if a unit is being used as a model/leasing office or one has been given to the onsite property manager to use, these factors affect economic vacancy as well.
Physical vacancy is an important indicator, but it won’t give you the entire picture. Make sure you look at the property’s income statements—not just the rent roll. That’s the only way you’ll get the whole story.
Skimping on Cash Reserves
Failing to hold enough cash in reserve when you purchase a property is a great way to ensure you find yourself struggling when unexpected maintenance expenses wreak havoc on your balance sheet.
When it comes to future property expenses, there are two things you need to account for up front: capital expenditures and maintenance reserves. The former refers to the major systems and appliances that effectively increase the value of the property. The latter refers to those recurring expenses which keep the property on an even keel.
To fund maintenance reserves, you’ll need to set aside a fixed amount per unit per year. This relegates maintenance expenses to its own line item in your budget.
Funding for capital expenditures on an ongoing basis is accounted for by holding funds in reserve, but it’s difficult to do when you first buy a property, unless you raise these funds with your equity when funding the deal.
In either case, the best way to anticipate and plan for maintenance costs and capital expenditures is to thoroughly inspect the property prior to the purchase, price out anticipated repairs/replacements, and re-evaluate your numbers to make sure the deal still makes sense.
Hoping for Appreciation
I call this the ‘crystal ball approach’ to buying and selling real estate.
In what used to be the standard method of investing, the crystal ball approach boils down to this simple slogan: buy low, sell high. Acquire a property under market value; then, turn it around a few years later for a quick and easy buck.
Without getting into its many logistical and financial pitfalls, I’ll point out the most obvious flaw in this approach: you can’t predict the future! No one can.
In a rising market, you may be able to get by with this approach for a little while. But, when the market turns (which at some point it most certainly will), you’ll find yourself in serious trouble.
If your sole reason for purchasing an investment property is a hunch that it’ll appreciate enough for the numbers to make sense, then you’re planning to fail. Instead, focus on cash flow. If the property can’t bring you sustainable income, then don’t buy it.
Betting on Future Cash Flow
Closely related to the previous mistake, investors get themselves in trouble by purchasing a property with negative cash flow without sufficient operating capital. They do this with the expectation that they’ll be able to get the property back into the black shortly after closing.
You may be able to get away with this risk, but once again you could be setting yourself up for a fall. More likely, you’ll get into the property and find increasing occupancy and/or rates to be a much heavier lift than you anticipated.
Then, you’re stuck with an underperformer that’ll drag you down or the rest of your portfolio.
Instead, go for cash flow on Day 1. If you can’t make the numbers work in your favor on the day of closing, then it’s time to either renegotiate or walk away from the deal.
In this post, we’ve looked at several of the most common mistakes I’ve seen in multifamily real estate investment. In summary, here are 7 positive reminders to keep you from making any of them yourself:
- Build a Team
- Stick to Your Criteria
- Take Your Time
- Pay Attention to Economic Vacancy
- Plan for Capital Expenditures and Improvements
- Aim for Cash Flow, Not for Appreciation
- Make Decisions Based on Today’s Income, Not Tomorrow’s
If you’ve found this helpful, I’ve included a special bonus section in my Lifetime CashFlow Academy course to cover these mistakes and several more.
For more information on common real estate investing mistakes, download my free book 29 Mistakes by clicking on the book below!
Do These 4 Things to Jump Start
Your Multifamily Investment Business
If you’re new to the multifamily investment business, then it’s easy to look at the scope of possibilities out there and stall out before you even get started. If that’s you, then the best way to get unstuck is to take concrete, deliberate action.
Here are 4 things you can start doing today
to get your business in gear:
1. Hit the Books
There’s a lot more to succeeding in multifamily investment than a head full of information. Still, you’ll need to get yourself up to speed on a few key topics if you hope to get anywhere.
Here are a few of them:
- How to Run Due Diligence on a Property
- Your State/City’s Rent Control, Eviction, and Anti-Discrimination Laws
- How to Structure a Business
- The Ins & Outs of Property Management
You’ve already started the learning process by reading this blog. You can find more even material in my free book on multifamily investing. You can also check out a few of my recent podcasts. Here are a few good choices for getting started:
As important as these types of resources are, there’s nothing quite as valuable as time spent learning from other experienced investors. To that end, make it a point to join a local chapter of NREIA or a nearby real estate investors’ meet up group.
I created the Lifetime Cashflow Academy to be a place where all these things can come together—high-level material, quality video instruction, and a community of successful investors dedicated to helping one another succeed. Click here to find out more.
2. Start Kicking Tires
Book learning is necessary, but not sufficient. If you don’t take the next step and translate that knowledge into hands-on practice, all you’ll have is a head full of ideas and none of the practical skills you need to start and run a successful business.
The only way to develop those skills is to get out there and start looking at deals.
Have you connected with a broker yet? If not, then now is the perfect time to start. Once you’ve got an idea of what you’re looking for (see #s 3 & 4), reach out to a local commercial real estate broker and see what they have available.
Take each deal seriously, even if the odds are low that you’ll buy right now. Do your initial due diligence—evaluate the market, take a drive by the property, assess the neighborhood, crunch the numbers; you can even meet the broker for a walkthrough.
Note: Make sure you respect brokers’ time and resources. If you aren’t ready to buy, let your broker know up front so that they don’t feel as though you’re wasting their time. You do not want to wreck a broker relationship before it even gets started.
Treat this as a dress rehearsal. Ask lots of questions and don’t be afraid to make mistakes along the way. As you do, lean on your broker for the market insight and wisdom. This is a great time to build that relationship. It’ll pay off in the future.
3. Decide on Basic Criteria
If you’re going to kick tires, you need to have a general idea of what you’re looking for.
Here are four basic criteria to decide on before you start looking:
Price – Don’t leave this up to a “gut” feeling about what you can and can’t afford. Meet with a lender and get pre-approved so you know what you can afford before you start looking.
Size – Don’t just think in terms of square footage and room counts; consider number of units as well. Anything less than 5 is considered a residential; anything above 5 is commercial. Residential plexes may be ideal for new investors, but commercial properties will ultimately make for a stronger portfolio.
Style/Condition – Are you looking for something modern or traditional; a quaint looking foursquare or a basic apartment building? Regardless of the style, how much work are you willing to take on in getting the property up to snuff?
Class – Commercial properties are broken down into 4 property classifications: A, B, C, D. These cover a range of property types, locations, and conditions, with A being on the high end of the spectrum and D on the low end.
4. Pick Your Market(s)
In addition to selecting the types of properties you want to pursue, you’ll also need to choose where you intend to find them.
Here are four market types to consider:
Backyard – Start where you live. As you gain experience and/or exhaust the possibilities in your location, you can branch out into other markets.
Hometown – Take a look at the town you grew up in. Odds are, you know it better than most other markets and will have family or friends nearby to help.
Boots on the Ground – Beyond your backyard and hometown, consider markets where you have friends and associates who can serve as your eyes and ears on the ground.
Retirement/Vacation Destination – If you know where you plan to retire, search for properties in that area. That way, you can keep an eye on your retirement portfolio without having to board a plane.
For a deeper look at picking markets and setting investment criteria, take a look at this post I wrote a few weeks ago on finding the “perfect” deal.
Try not to look at these things as a sequence of one-time actions. Instead, consider them ongoing and complementary activities.
Seek out as many opportunities to study and learn as possible.
Revisit your market choices based on the realities you encounter on the ground.
Refine your criteria as you learn more about what works in your market.
Never stop looking for and evaluating potential new deals.
Don’t overthink things at this point. Put your head down and press forward on each one of these activities. Before you know it, you’ll be ready to put your money on the table and start building massive wealth through multifamily real estate investment.
Investing in Multifamily Properties
While Working Full-Time
Do you want to invest in multifamily properties but you’re worried about losing that income from your full-time job? What if there was a way that you could invest in real estate AND keep your 9-5 income stream?
Fear of losing your income while investing in multifamily properties is the single most cited reason we’ve seen that holds back a new investor.
In response, we had a specialist in our firm compile a strategy to help you. Below is a brief outline of the major points of this strategy.
One Initial Possibility to Consider:
If you’re in the market for a new 9 to 5 job, consider looking for one in the real estate industry. That way as you collect
a steady paycheck, not only are you learning what you need to know but you’ll be on the front-line when properties go to
market. Here are some positions that might interest you:
- Working for a property management company
- Leasing agent
- Live-In manager at an apartment complex
- Working for a private investor
Once you start investing, 4 Key Components will determine your success:
Without a strong system any endeavor will collapse at some point. Every business is comprised of only two things; systems and people. Automate as much as you possibly can. Using a CRM will keep your list of contacts up-to-date as well as automate tasks for you, saving you time and money. For instance, you can schedule your CRM to:
- Auto email campaign to agents/brokers
- Auto email campaign to buyers and investors
- Automatic “thank you” email to seller leads when they opt-in to your site
Your time is precious! Being organized will not only keep you focused on your long and short term goals but also help you prioritize which tasks will bring you a higher return. Learning to spend your time wisely will reward you richly. Apply the “Pareto Principle” of 80/20 to your scheduling, where 20% of your input accounts for 80% of your output. Determine which tasks result in 80% of the traction towards your goals and put your focus there.
3. Your Team / Virtual Assistants
Start delegating your workload and you’ll achieve more. You can hire Virtual Assistants (VA’s), freelancers globally for less than $5/hr. If your time is worth $50/hr you shouldn’t be doing $5/hr tasks! Here are some examples of things you can affordably outsource to recoup your time:
- Steps of building your database
- Data entry
- Building a foreclosure list
- Posting Craigslist ads
- Website updates
- Updating your database
- Sending you leads
- So much more!
“Don’t rush out in the middle of the night with a plunger in your hand!”
Hire a property manager and use your time where it matters most. Did I say your time is precious? You can do anything but not everything… and truthfully there are some things you’d probably rather not do.
Another way to create a steady income from real estate investment while still keeping your full-time job is: Wholesaling. Be on the lookout for more resources from us for wholesaling soon!. Wholesaling is finding real estate and putting it under contract for the purpose of assigning that contract to another investor for a quick and tidy profit. The many benefits of wholesaling include:
- It can be part time
- Get into multifamily real estate for little or no money
- Make quick cash in basically any market
- Accumulate cash to purchase “buy and hold” rentals
- Focus solely on money-making activities
- Gain experience with little risk
- Build a strong network
- Start now and not wait until you have money saved or a higher credit score
Set daily attainable goals for yourself and prioritize your tasks to get you closer to the realization of those goals. It might not be easy but it can be done. I hope that you have found the information I’ve provided to be valuable and that it helps you get closer to achieving your goals of investing in multifamily properties.
10 Ways to Find Good Real Estate Deals
When it comes to finding deals, I often refer to the 150-15-5-1 formula. For every 150 properties you look at, 15 will be worth pursuing. Out of those 15 properties, you’ll submit an LOI or a contract on 5, and out of those 5, you’ll probably only close on 1.
In other words, you’re going to have to look through a lot of properties before you land on one that’s worth your time and money. That means you’re going need to employ a handful of strategies to help you pull in a steady stream of property leads.
1. Broker Relationships
There’s an old saying in the real estate investment industry: “One good broker can make you wealthy.”
That’s absolutely right. So, the first thing you’ll need to do is connect with the most active brokers in your target market(s). Developing relationships with these brokers is one of the most fundamental strategies you can adopt in looking for multifamily deals.
A good broker will know his or her market inside and out. They’ll have the inside track on potential deals long before they ever hit the market—that is, if they even hit the market at all.
Begin by identifying the brokers in your market who do the most business. You can find out who’s staying busy by logging into LoopNet and searching the commercial multifamily listings in your market. Take note of the brokers who have the most listings and reach out to them.
“Once you’ve decided who to contact, pick up the phone and give them a call.”
Identify yourself and give a clear description of your specific investment criteria. Busy brokers don’t have time to burn with wishy-washy investors. Be courteous and professional—make it clear that you’re serious about investing in real estate.
Take whatever time you can to chat with the broker, as well. Find as much common ground as possible. You won’t be the only investor on their radar, so it’s crucial that you focus on building a relationship.
We all prefer to do business with people we know and like, so establishing a personal connection with the broker will give you an edge over your competition.
From there, follow up regularly. Even if they send you properties that have no potential to satisfy your criteria, take the time to respond and explain why you’re not interested.
Constant contact is the key to ensuring that, when a hot property does come available, you’ll be the first person that broker calls.
2. Pocket Listings
When you connect with a broker, you set yourself up to tap into a potential goldmine of ‘pocket listings.’ A pocket listing is simply a property that a broker’s been tapped to sell but, for one reason or another, isn’t being publicly marketed.
The typical way to get pocket listings is to develop a relationship with a broker and persuade them to contact you first when new opportunities arise.
But, there’s another way to get access to pocket listings that virtually everybody overlooks. Here’s what you do:
- Conduct your market research and choose a specific area to target.
- Build a database of all the properties that meet your criteria in that area
- Pull contact information for each property owner. For properties owned by LLC’s, dig deeper to find the phone number and address of the actual living, breathing human being who owns the property.
- Find a young, hungry broker in your target market who’s willing to spend a significant amount of time on the phone. Set up an interview with them and establish a few ground rules for your working relationship.
- Give the broker your database. Make it clear that these are all properties that you’re willing and able to purchase At this point, you’re basically giving the broker a listing of hot leads.
- Now, turn the broker loose to work these property owners and solicit deals on your behalf.
This entire process sets up an attractive win-win for you and the broker. He or she gets a list of leads and you get the inside track on properties that meet your investment criteria.
Once you have this established in one market, you can repeat the process for each of your target markets.
3. Online Listings (New Properties)
It’s sometimes said that online sites like LoopNet are where deals go to die.
I’m not sure where that sentiment comes from, but it’s almost surely false. The reason brokers spend the time and money to post deals on LoopNet is that the site actually gets results!
In addition to LoopNet, a few other sites to check out are Cityfeet and the Commercial Investment Multiple Listing Service.
Several of the big commercial brokerages have their own listings as well:
- Marcus & Millichap – http://www.marcusmillichap.com
- CBRE –http://www.cbre.com
- Cushman & Wakefield – www.cushmanwakefield.com
- Coldwell Banker Commercial – www.cbcworldwide.com
One of the best ways to utilize these sites is to set up keyword alerts so that you’ll be notified as properties that match your criteria hit the site.
As the saying goes, “If you’re not first, you’re last.”
You have to jump on these properties as soon as they hit, or else someone else will.
4. Forgotten Listings
Another strategy for finding deals online involves looking properties that have been passed over and left to languish on the site for several months or even years.
Most buyers pass over these properties, thinking there must be something seriously wrong with a property that’s been on the market for so long.
But, that’s the wrong way to look at it.
Not too long ago, I came across a 24-unit property near Tampa that had spent 3 years on LoopNet. The cap rate was low, and the property description was sparse, which explains why buyers passed it over.
When we called the broker, though, we learned that the sellers were in their 90’s, didn’t own a computer, and took care of everything by hand.
We also learned that the rents were $150 below market and they were paying way too much for maintenance and landscaping.
All this made improving cap rate on this property was as simple as renegotiating a few contracts and raising the rents up to market. I think of that as low-hanging fruit.
This property was an instant value-add, and even though 1000’s of people had seen it, not a single one had dug deep enough to see its potential.
There are deals like this one sitting on LoopNet today. All you have to do is look.
Craigslist often gets a bad wrap because of its simplicity. Every year, investors ditch the platform in favor of other more technologically advanced solutions.
But, do you know who hasn’t given up on Craigslist? Multifamily sellers! Especially mom-and-pop sellers who’d rather not deal with real estate agents.
Craigslist works best for 2-30 unit properties, but that doesn’t mean you can’t find larger ones on their as well. Once in a while, I’ll come across a complex with upwards of 80 to 100 units.
There are a couple of different ways to use Craigslist for finding a deal:
- Troll the ‘for sale’ section. Spend 5-10 minutes each day working through the for sale section in each of your target markets. You’ll be surprised how few people do this. If there are too many properties for you to sort through, do a keyword search and focus on ones that include words like these:
- Must sell
- Must sell quickly
- Investor special
- Needs work
- Post ads of your own. Posting an ad on Craigslist is easy and free. It takes just a few minutes to do. Unfortunately, there will be plenty of investors in every market adopting the same strategy. Still, if you’ll spend a few minutes each day posting ads, this is a relatively low-maintenance way to bring in leads.
- In your ad, focus on potential pain points like these:
- “Sick of dealing with problem tenants?”
- “Tired of late rent and evictions?”
- “Is your income property not producing any income?”
- In your ad, focus on potential pain points like these:
- Call FSBO’s. Look for ads posted by owners who’d rather not use an agent. When you reach out to these owners, make it clear that you’re not obligated to a broker and that you can close quickly with a minimum of hassle.
6. Cold Calling ‘For Rent’ Ads
The next strategy involves calling on ‘for rent’ ads. You can find these ads on Craigslist or Facebook. You can also find them in your local newspaper.
At first blush, it might seem a bit strange to reach out to landlords who’ve advertised their properties for rent and not for sale. And, to be honest with you, several of them will be frustrated to hear from you. So, prepare yourself for a healthy amount of rejection here.
But, let’s look at it from another angle.
If an investor has his or her unit listed for rent, it means it’s vacant and their income producing property has stopped producing income. That’s a pain point.
Add to that the frustration of tenant turnover, the costs of unit repairs, and the rigamarole of screening and signing new tenants and you’ve got a handful of compelling reasons why a seller may want to get rid of their multifamily.
To make the most of this strategy, focus on self-managed multifamilies. If you call on professionally managed properties, you won’t get the owner. You’ll get a leasing agent with no ownership interest in the property and, frankly, no good reason to relay your offer to the property owner.
How do you tell the difference between self-managed and professionally-managed listings?
Look for these things:
- Sparse, low-quality imagery on the property listing.
- A poorly-worded and insufficient property description.
- A long-distance area code.
- Motivation Keywords:
- Must rent
- Need to rent
- Maybe for sale
- Will sell
- First month free
As I said, the majority of these landlords won’t be interested. But, if you keep working the phones and working the numbers, you’ll occasionally find an owner who couldn’t be more eager to entertain your offer.
7. Direct Mail
Hands down, direct mail is the most effective way to find off-market multifamily deals.
We could do an entire video on direct mail. In fact, I already did a few weeks ago. I’ll give you a few of the broad strokes right now, but I’d encourage you to go take a look at that video for a more in-depth look at direct mail [provide link to that video].
Most owners of 2-30 unit properties are mom & pop types. They’re often older, so you won’t find them on the internet. The best way—sometimes, the only way—to get in touch is via mail.
With a direct mail campaign, you can systematically reach out to these property owners over an extended period.
The keys to developing a successful direct marketing campaign:
- Develop a targeted list. The success of your direct marketing campaign will depend on the quality of your list. Be sure to narrow down your market and the precise properties you’d like to pursue. Otherwise, you’ll waste a significant amount of money marketing to the wrong people.
- Write persuasive marketing material. Keep your letters short and to the point. Present yourself as a problem solver, offering to alleviate the seller’s pain in the quickest and easiest way possible.
- Set a budget you can sustain. Longevity is key in direct mail. It’s better to engage a small list consistently for a year than to mail out to a bloated list and run out of money 3 months in.
- Persevere. The vast majority of property owners will ignore your direct mail letters. Don’t take that personally. Not everyone is ready to sell today. But, by systematically mailing owners over time, you’ll earn yourself a share of their attention, so that when the time does come to sell, you’ll be the first person they think of.
8. Calling Your Database
This next strategy builds on several of the previous strategies.
Whenever you come across a property owner’s contact information—whether that’s by responding to a Craigslist post, calling a ‘for rent’ ad, or adding them to your direct mail campaign—be sure to save that information in your CRM.
Don’t just call the owner and then forget they ever existed.
Instead, take scrupulous notes in your CRM and then plan regular followup calls. Most CRM platforms will allow you do this by scheduling regular follow-up reminders.
As with direct mail, this is a numbers game. You can expect the majority of these calls to end with a ‘no.’ Don’t lose heart. Focus on building a relationship with each of these people over time.
Again, there will come a day when they’ll be ready to sell. When that day comes, you want to be the investor they just spoke to a few weeks prior.
9. Bank REOs
Whenever a bank forecloses on a loan, it has to take possession of the foreclosed property. These properties are known as REO (real estate owned).
You might think that’s a good thing for the banks. Actually, it’s not.
Bankers don’t want to be in the property management business—they’re just not set up to rent and manage properties. That makes each REO property more of a liability than an asset.
This puts the savvy real estate investor in the position to become a major problem solver for the bank.
If you can position yourself as a competent and capable problem solver, you can do the banks the favor of helping liquidate their REO assets. This is a win-win: they can drop the dead weight from their books, and you can collect investment properties at well-below-market prices.
Building relationships here is key. A bank won’t want to work with an investor without a prior relationship. You can develop one by working with them on a few deals before broaching the REO question.
10. Wholesalers and Birddogs
The last strategy I’m going to share involves recruiting and hiring other people to find deals for you. I want to talk specifically about the two kinds of people who’ll help you most here: wholesalers and birddogs.
A wholesaler is (usually) another investor who focuses on scouting out deals, getting them under contract, and then assigning those contracts to other investors for a fee. You can find wholesalers in every market in the U.S.
If you’re going to enlist the help of a wholesaler, be sure to let them know that you don’t want them sending you anything you can find online. You want truly off-market deals, and you’re willing to pay a premium for them.
A birddog (usually) isn’t an investor. They won’t get a property under contract and assign it to you. Instead, they feed you leads for a fee. The best birddogs are usually people who drive for a living: postal workers or delivery drivers. They’re in the best position to “drive for dollars” on your behalf.
To avoid legal trouble, you’re better off paying birddogs per lead rather than per deal. Supply them with an information sheet to fill out for each property they come across. Pay a flat fee for each sheet they turn in that meets your investment criteria.
Today, we’ve looked at 10 practical and effective strategies for finding deals.
To summarize, here they are again:
- Build relationships with brokers.
- Give your broker a way to pick up pocket listings.
- Utilize online sites.
- Look for forgotten properties.
- Get on Craigslist.
- Cold call ‘for rent’ ads.
- Use direct mail.
- Call your database.
- Help banks unload their REO property.
- Enlist the help of wholesalers and birddogs.
Don’t feel like you have to put every one of these strategies in motion today. Consistency is key. Pick one or two that you know you can execute well and, then, fold in additional strategies over time.
What You Need to Know About the Letter of Intent
The other day, a member of our Multifamily Community Facebook Group had questions about when and how to use a letter of intent. This isn’t the first time I’ve had someone ask me about this topic, so today I’m sharing that information here on the blog.
What’s a Letter of Intent?
The letter of intent (LOI) is a written ‘handshake’ agreement between two parties indicating their mutual desire to enter into a binding contract or lease.
In a real estate transaction, the purpose of an LOI is to create a (mostly) non-binding agreement between the Buyer and Seller so that both parties can begin to negotiate in good faith.
When to Use a Letter of Intent
There are two general ways to make an offer on a property.
The first is to draw up a complete purchase and sales agreement with your desired terms and present it to the seller. More often than not, this will involve the help of a lawyer and will cost you time and money.
The second is to write up and submit an LOI. This simple one- or two-page document will be sufficient to get your desired terms out on the table and begin the conversation with the seller. If you find that you won’t be able to reach an agreement, you won’t have wasted the time and money necessary to draw up a contract with your lawyer.
What to Include in Your Letter of Intent
Given its intended function, the LOI doesn’t have to be anywhere near as complex as a full-blown purchase and sale agreement. If and when the Buyer and Seller come to terms, the contract will expand upon every term in appropriate detail.
That said, here’s what should go into a good LOI:
- Biographical Information – Begin by specifying the full names, addresses, and contact information for each of the parties involved in the transaction.
- Purchase Price – Indicate your opening bid on the property. This figure will likely change in negotiation. At this point, however, getting the number out there quickly will help see if you and the seller are on the same page.
- Down Payment and Loan Terms – If you’re going to make the deal contingent on financing, specify the basic terms of the loan you plan to secure.
- Escrow Company – Include the name and contact information for your title attorney or escrow agency.
- Closing and Conveyance – Specify the attorney who will close the transaction as well as your anticipated closing date.
- Conditions/Contingencies – This section is especially important. In it, you’ll set yourself up for the due diligence that will immediately follow a binding purchase and sales agreement. Be sure to include provisions for financing, appraisal, title survey, physical inspection, and document review (including current leases, rent rolls, income statements, and service contracts).
- Earnest Money – Specify the amount of earnest (“good faith”) money you intend to submit if and when a contract is written. This money is your guarantee that you’ll hold up your end of the deal. The purchase and sale contract will contain precise language for how earnest money is to be handled.
- Costs/Expenses – If you’d like the seller to cover the cost of a title insurance policy, you’ll want to make that known in your LOI. Additionally, you’ll need to specify who’s expected to cover which portions of the closing costs associated with the property. Finally, make sure to address tax and utility prorations as well.
- Contract Assignment – Though not absolutely necessary, I suggest you retain your right to assign the contract to another party if you so choose. This will not only give you an option to ‘sell’ the deal to another investor but to transfer it into an LLC.
- Personal Property – Transfer of personal property can often be fraught in real estate transactions. It’s important to specify—in detail—which items you’d like to remain with the property so that there can be no dispute later.
- Broker Commission – If there are brokers involved on either side of the commission, be sure to indicate their commission figures as well as who’s expected to pay.
- Exclusivity/Non-Shop/Non-Solicitation – This is one of the most critical sections of your LOI. In it, you’ll specify that the Seller is by no means to market the property or to solicit other buyers so long as this LOI is in effect.
- Confidentiality – Make sure to include language that prevents either side from disclosing information about the deal to a third party without written permission.
- Additional Stipulations – If you have any further requests that haven’t been addressed in the previous terms, add them in the final section of your LOI.
To Bind or Not to Bind
Close your LOI by indicating that all but the exclusivity and confidentiality portions of the letter are not legally binding. If you fail to do so, then the LOI could be interpreted as a legally binding contract, opening you to unnecessary obligation and legal liability.
The letter of intent is a low-pressure way to indicate your serious interest in purchasing a property and give you protected time to investigate further without worry about losing out to a competitor. For those reasons, I’d recommend you use an LOI on every deal.
For more on letters of intent, along with an example, check out my free book on Multifamily real estate investment.
How to Sell a Seller on Seller Financing
There will come a point in your business when the most challenging part isn’t finding deals; it’ll be sourcing the funds to pay for those deals. Don’t fret. That’s a wonderful place to be! Today, I want to talk about one way to creatively fund your deals: seller-financing.
In a nutshell, seller (or owner) financing means that, instead of going through a bank or a private money lender, you get the seller of a property to agree to carry the note for your financing.
The mechanics are similar to a conventional loan, but the seller serves as the lender.
From a buyer’s perspective, there are plenty of reasons to go after this type of funding arrangement:
1. You don’t have to worry about strict qualification guidelines.
2. You can avoid the typical origination fees that come with a bank loan.
3. You’ll have the flexibility to negotiate better terms.
4. You can pass on the usual headaches that come from loan underwriting.
5. You can close much more quickly than with a regular loan.
That all adds up to one compelling case in favor of seller-financing. But, my purpose today isn’t so much to sell you on the advantages of getting a seller to finance your next deal.
Instead, I want to equip you to convince a seller that loaning you the funds to purchase their property would actually be a better choice for them.
A Quick Note on How to Approach the Conversation
Notice how I said I’m going to show you how to convince a seller that this would be right for them. If you’re going to pull this off, then you have to begin with the honest conviction that seller-financing is, in fact, a smart option for the seller.
If you’re looking for someone to teach you how to pull the wool over some unsuspecting seller’s eyes, then you’ve come to the wrong place. I sincerely believe that getting a seller to carry a note for you can genuinely be their best course of action and often in their best interest.
Why I believe that will become clear as we go.
All that to say, when you interact with a seller—from the very first time you make contact until closing day—approach from a standpoint of mutual value.
Honestly seek to create a win-win scenario at every point.
Build rapport by taking a genuine interest in their specific situation. Identify pain points—areas in their life that would be genuinely enriched by selling you the property as quickly and painlessly as possible.
Offer solutions that solve their problems, not just your own.
If you can build the relationship on those grounds, the owner will be far more open to a conversation about seller-financing.
Three Key Benefits to Seller-Financing for the Property Owner
Before you start the conversation, you need to get crystal clear on the specific value you have to offer by proposing a seller-financed deal. Otherwise, you won’t get very far with your seller.
To that end, here are the three key benefits a seller can expect from this arrangement.
1. Speed – Without the red tape of financial institutions, you can close a seller-financed deal just as soon as you can complete your due diligence. For a seller, this means a quick and painless closing whereas a traditional lender-financed deal could take weeks or months, especially if there are problems in underwriting or appraisal.
2. Tax Advantage –For sellers who’ve owned their property for more than 27 years, their tax basis will be all but gone. That means Uncle Sam’s going to take a big bite out of their profit on this sale. If on the other hand, the seller agrees to finance your purchase, then they’ll only be on the hook for taxes on the mortgage income they bring in each year. This is a huge benefit for the seller.
3. Cash Flow – A monthly mortgage payment from you means guaranteed cash flow for the seller. And monthly check comes free of all the usual work that goes into managing a property. For them, it’s purely passive income. This income is usually significantly more than they would earn from a bank or bond.
How to Explain Seller-Financing to the Seller
Talk about Benefits, Not Features
This is Sales Training 101. When you’re talking to the seller about carrying a note on the property, the last thing you want to do is frame it as a ‘favor’ to you. If you were paying attention a few moments ago, you’ll know that seller-financing looks a whole lot more like a favor for them!
That said, focus on explaining the benefits clearly and concisely. Do your homework. Be ready to answer questions. Even sketch out an example using real numbers to help show them how the deal will work for them.
I’m going to give you an example of what that looks like in just a few minutes, but before I do, I need to say a few things about potential objections.
Proactively Address Objections
Sellers are going to raise questions about and objections to your proposed funding arrangement. Don’t see these as deal breakers. Instead, take them as opportunities to keep the conversation going and provide additional assurance.
I’m going to give you three of the most common objections I hear along with a few ways to get out in front of them.
“What if you were to pass unexpectedly? How would I be protected?”
Fair enough. The seller wants to know what happens if I pass away. Will they have to deal with a family member or executor? How will they ultimately get paid?
For this one, I pledge to take out a term life insurance policy on myself with a death benefit sufficient to pay off the balance of the loan and direct that the funds only be used towards that end.
“How do I know you’re not just going to run the place into the ground and then disappear on me?”
Again, this is a fair question. The last thing a seller would want is for you to purchase the property using their financing, run it into the ground, and then leave them holding onto a dog of a property with little to no prospects of reselling it at market value.
To help alleviate the seller’s concern, you can structure the deal to include a management provision stating that, if the occupancy of the property were to fall more than 15% below its current rate, then the seller could call the note to be paid off within 90 days.
“What if I decide I don’t want to be a lender anymore?”
The owner may get 5 years down the road and decide he doesn’t want to be a lender anymore. Maybe he just wants to take the lump sum—taxes and all—and go retire someplace sunny.
That’s fine. There’s no reason why he wouldn’t be able to do that. What I’d do in this case is connect him with a mortgage broker to talk about possibilities for selling the loan in the future. There are investors out there who’d gladly buy the note for the right price.
Sketching an Example
Here’s a script of what you might say to a property owner. For the sake of this example, we’ll assume he purchased the property 30 years ago for $500,000 and is currently asking $3 million for it. You’ve done your homework decided that’s a fair price.
There is not much you can do to prevent the IRS from taking a substantial chunk of your capital gains. That said, you stand to net about $______(65-70% of their net) after taxes and fees if you decide to sell the property outright.
Let’s say you do decide to go that route. To be safe, I’m sure you’ll want to park the money in a fairly protected investment vehicle—probably a CD or money market. If you’re lucky, your high volume will earn you a premium rate of about 2% in interest. That makes for $________ a year in interest income.
But…If you work with me, I will pay you 3,4,5 or 6% interest and you will only pay taxes on the amount you receive each year. Your payment from me will be $_______ which as you can see if 3-4 times what you would get from the bank
We’ll be able to close in two weeks, possibly sooner, so long as I can complete my due diligence on the property and you can verify my credit-worthiness. That’s a much safer and faster option than trusting a buyer with the hassles of conventional financing.
As long as you and I are bound together by this note, our arrangement will be secured by this $______ property. What other investment vehicle could you find that will back up their promise of a $________per year return with a $______ guarantee as security?
Thanks again for taking a look at this. As you can see, we both have quite a bit to gain from this arrangement. Is all of this clear? Are there any specific questions I can answer for you?
Of all the creative ways you could finance a deal, seller-financing is one of the most attractive. It gives both sides—buyer and seller—plenty of reasons to walk away from the deal feeling like they’ve won.
More importantly, it gives you one more tool in your bag to make sure you never have to pass on another deal because of trouble with financing.