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.
6 Reasons to Make Your First Home a Multifamily Property
There are few things in life that are more exciting than buying your first home. In all the excitement, however, starry-eyed first-time buyers often miss this simple fact: buying your first home is a critical moment in your financial journey. In this post, I’m going to help you think strategically about how to make the most of that moment. How? By focusing specifically on residential multifamily property. In fact, I’d argue that making your first home a multifamily could be one of the wisest investment decisions you ever make. Here are 6 reasons why I can say that:
1. Jump Start Wealth Building
Homeownership is the most powerful driver of wealth accumulation in the U.S. economy. In 2015, the average net worth of a homeowner was just under $200,000. For a renter, that number was barely above $5,000.
The average homeowner usually focuses more on putting a roof over her head than building wealth. I’d argue that’s a shortsighted way to look at purchasing your first home. Indeed, your first house is an investment property, whether you realize it or not.
So, why not think like an investor and maximize the opportunity before you? By choosing to purchase a multifamily property as your first home, you’ll ensure that the very first property to hit your portfolio is a solid earner that will last you a lifetime.
2. Ride with Training Wheels
What I’ve said so far requires you to think and act like a real estate investor. That can be a daunting task, especially if you’re standing on the outside listening to stories of investors who consistently deal in 200+ unit complexes.
This may come as a surprise, but the mechanics of purchasing a duplex aren’t all that different from that of an apartment complex. They only come in a smaller scale.
So, by starting early on with a smaller residential multifamily, you can begin to develop the fundamental skills you’ll need to move on to bigger properties in the future.
It’s never too soon to get into real estate investment—even when you’re looking for your first house.
3. Have Other People Pay Your Bills
Imagine you’re purchasing your first place and you’ve got the means to secure a $250,000 loan. So, you throw 3.5% down on a 30-year FHA loan at 3.75% interest. That makes your monthly mortgage payment (without taxes and insurance) $1,306 a month. Since you’ve bought a single-family, that entire mortgage load rests on your shoulders.
Now, imagine you decided to go with a similarly priced duplex instead. For the sake of this scenario, let’s say rental rates in your market are sitting at around $800/mo for a 2-bedroom. So, you buy the property, live in one unit while renting out the other. Just like that, you’ve reduced your monthly mortgage load to $506.
Take it a step further and imagine you purchased a triplex instead. At this point, your mortgage is more than covered. Now, you’ve got the option to dump that money into your equity, make improvements to the property, or cover your other bills.
4. Economy of Scale
You’ll notice that in each of those scenarios I envisioned above, you only had to purchase one property. That means only one negotiation, one loan, and one contract-to-close process. It also means one physical property to keep your eye on rather than 2, 3, or 4 scattered around the neighborhood.
Therein lies the beauty of multifamily real estate; you reap the benefits of having four separate income properties with only a quarter of the hassle.
More importantly, your acquisition costs per unit drop as you purchase higher-capacity multifamily properties. Not only will that help you to secure financing, but it’ll improve your cash-on-cash returns.
5. Easier Financing
Thanks to programs like FHA, financing can be much easier to obtain for a du-, tri-, or quadplex than for a commcerical multifamily property. The terms will generally be more favorable as well. On top of that, one of the most common funding hiccups for new multifamily investors is their lack of experience. Without a proven track record, lenders are less likely to make a commercial multifamily loan. This locks new investors into a bit of a catch-22. You need the experience to get the property, but you need to the property in order to get the experience. But, if you use FHA to purchase a multifamily property as a first-time buyer, you can easily kill both of those birds with one stone—all while locking in a relatively low monthly debt load.
6. On the Job Training
Managing an investment property is not for the faint of heart. Keeping up a successful income-producing property takes both business acumen and emotional intelligence.
That said, no one is born with an innate set of property management skills. Everyone has to cut their teeth somewhere. What better way to do so than on your home turf?
As the on-site manager for your own property, you’ll have a firsthand view of everything that goes on with the building, your tenants, and the neighborhood. With everything in arm’s reach, you’ll be able to monitor and manage your property far better than you could if it were located halfway across town.
Learning to landlord is one of the most important things you can do early on in your investment career. One day, you’ll hire other people to manage your properties. Having built up this skillset, however, you’ll know exactly what to look for in a new hire.
If you’ve read any of my other stuff, then you know just how much I believe in multifamily investment as the way to build up life-changing wealth. That’s especially true when you’re first getting started out in real estate.
That said, it’s never too soon to get into real estate investment—even when you’re looking for your first house.
A Quick Guide to Business Structures
for Real Estate Investors
The difference between amateur and professional real estate investors has nothing to do with the size of their portfolios. The fundamental difference is this: while amateurs make a hobby of buying and selling properties, professionals treat real estate as what it is—a business.
If you’re going to succeed in multifamily real estate investment, you need to go and do likewise. Part of that means setting up the legal structures that define your business as a stand-alone entity. As you advance, that’ll also involve structuring multiple entities depending on the specific properties and investor relationships you want to protect.
Structuring your business, however, is about more than making yourself look and feel like a professional. More importantly than all that, your legal structure will provide you two key benefits: personal liability and tax sheltering.
In today’s post, I want to look at four of the most common types of business structures to help you decide which one will be best for you.
A sole proprietorship is just as it sounds: a one-man shop for real estate investment. This is otherwise known as the no-structure structure.
What are the advantages?
Ease and simplicity. To buy real estate as a sole proprietor, all you have to do is use your legal name and social security number. You could use a DBA to buy and sell property under a company name, but the legal structure will essentially be the same.
What are the disadvantages?
As a sole proprietor, you’re on the hook for any and all damages resulting from lawsuits filed by tenants and business associates. If a judge were to rule against you in court, they could go after all your assets, including your personal home.
As if that weren’t bad enough, sole proprietorships do nothing to shelter you from unnecessary taxation. In fact, all your non-passive income will be subject to an additional 15.3% self-employment tax.
Is it good for multifamily real estate investment?
On the opposite end of the spectrum from the sole proprietorship, incorporation forms a more rigid, tangible business structure. There are two types of corporations you can set up: a C-Corp and an S-Corp. Let’s look at the C-Corp first.
What are the advantages?
Two significant advantages attend incorporation. First, using your corporation to hold property will protect your assets from any potential judgments against the corporation. Second, you can borrow funds in the company’s name, which can also be a useful tool in shielding yourself from personal liability.
What are the disadvantages?
In a C-Corp, your income properties will be subject to double taxation: first, at the corporate level, and then at the personal level for any distributed income. If you try to get clever and hold back that income from distribution, the IRS will hit you with a 15% personal holding company (PHC) tax.
Double taxation will also bite you when it comes time to sell properties you’ve owned for more than a year. Whatever gains you realize will be taxed at a high corporate rate. Any distributions you take from those proceeds will again be taxed at your personal rate.
Is it good for multifamily real estate investment?
In some circumstances, investors will use a C-Corp primarily for purposes of financing. In most cases, however, there are better options for offering liability protection without having to take on an additional tax burden. The S-Corp is one of them.
The S-Corp is similar to a C-Corp in terms of its legal structure and filing requirements. The S-Corp, however, enjoys a special taxation status under the Internal Revenue Code Subchapter S.
What are the advantages?
The S-Corp is not subject to double taxation. Instead, profits and losses pass through to the company’s shareholders. As an added benefit, shareholders can be “hired” as employees of the corporation. This gives you the flexibility to distribute a portion of profits as bonuses which are not subject to ordinary Social Security and Medicare taxes.
What are the disadvantages?
Not all states recognize the S-Corp’s special status and, consequently, tax both corporations in the same way. Also, only individual U.S. citizens can participate as shareholders. Other entities (other C-Corps, partnerships, LLCs) cannot own a stake in your S-Corp.
No more than 25% of an S-Corp’s income may be passive—including rental income. Any excess will be charged at the max corporate rate of 35%. For multifamily real estate investors, that represents a serious problem.
Unfortunately, whether you go with a C-Corp or an S-Corp, you won’t be able to avoid paying up to 35% in capital gains taxes. While you may be able to use a 1031 exchange to mitigate that tax burden, each shareholder will need to be eligible for the exchange.
Is it good for multifamily real estate investment?
If it weren’t for the added tax on excess passive income, the S-Corp would be an attractive option for real estate investors. With a long-term strategy focused on generating passive income, however, that makes the S-Corp functionally equivalent to a C-Corp, only with a free-pass on double taxation for 25% of your income.
Somewhat like incorporation, partnerships are a legally binding arrangement between two or more entities with specific guidelines for how the business will be run. Unlike a corporation, however, the partnership is not a legal entity in and of itself.
There are two types of partnership: general and limited.
What are the advantages?
Since partnerships are not legal entities, they’re not subject to double taxation. All income and losses pass through to the partners themselves and are taxed individually.
What are the disadvantages?
General partnerships offer nothing in the way of liability protection. For that, you would have to up a limited partnership, which is made up of at least one general partner and then one or more limited partner. As a passive investor, the limited partner is shielded from personal liability judgments. That partner must, however, remain truly passive. If they participate materially in any part of the business, they will lose their limited status.
Is it good for real estate investment?
Partnerships used to be more widely used, but their precarious liability protections have caused investors to look for a better solution.
Limited Liability Company (LLC)
In recent years, the LLC has emerged as a great hybrid solution for real estate investors. With the liability protection of a corporation and the tax advantages of a partnership, the LLC as the superior choice for most real estate investors.
What are the advantages?
Like a corporation, an LLC requires an operating agreement, only without the requisite annual meeting and elected board of directors. Instead, an LLC can be managed directly by its shareholders or indirectly by a designated manager.
In most cases, using an LLC to buy and hold your real estate investments will protect your assets from any judgments levied against the LLC itself. If the LLC is set up as a pass-through, then you get to enjoy this benefit without having to pay any additional corporate tax.
Also, in an LLC you can distribute profits and losses as you see fit, allowing you the flexibility to negotiate tax-preferential treatment for certain outside investors based on their individual needs.
What are the disadvantages?
An LLC won’t protect your personal assets against every legal judgment. If a tenant sues after being discriminated against by an on-site manager, for example, then you’ll be protected because the suit took place entirely within the LLC. If, on the other hand, you yourself were to cause someone harm—a motor vehicle incident or an instance of proven personal negligence—both you and the LLC could be on the hook.
Using personal finances to fund an LLC can weaken the barrier between your company and your assets. If you fail to keep all your finances strictly insulated from the LLC, a lawyer can and will come after your assets in court.
On the financing side, any recourse loan written for a property within the LLC will likely require a personal guarantee from each member. If you sign that guarantee, then you’ll be liable for any remaining debt obligations should the LLC default on the loan.
Is it good for real estate investment?
Of the structures we’ve looked at, the LLC is your best bet. It gives you all the personal liability advantages of using a legal entity to buy and hold real estate with none of the additional tax burden.
Based on what I’ve shared above, the LLC will be the better choice for most of the investors who read this blog. Of course, your best bet will be to chat with your lawyer before you make any final decisions.
A parting word of advice: whichever structure you decide to employ, supplement your personal liability protection with a high-value umbrella policy. These policies are relatively cheap and could potentially save you millions of dollars in the long run.
The Incredible Power of Visualization to achieve all of your dreams in Real Estate and in Life, and How to Create your own Vision Board.
Have you made your own vision board yet? If so, please share! Visualizing your dreams will allow you to achieve them! Learn how I use this process to continually remind myself of my goals and motivations.
As a thank you for joining me today, I’d like to offer you a free vision Board Blueprint to help you attain your goals by visualizing the success you want in your life. Click to download for FREE –> https://goo.gl/bFkpua
And also invite you to my new private group of multifamily real estate investors, visit –> Multifamilycommunity.com
To Your Success! -Rod
Have you ever considered how the United States government can help jumpstart your real estate investment business? A loan backed by the Federal Housing Administration (FHA) just might be the perfect option for investors looking to acquire residential multifamily property (2-4 units).
Today, I want to offer an overview of FHA loans, along with the pros and cons, and a closing recommendation about whether and how multifamily investors should use them.
What’s an FHA loan?
Established by the National Housing Act of 1934, the FHA has been a useful tool in promoting home ownership. Strictly speaking, the loan doesn’t come from the FHA, but from your lender. The government’s role is to insure those funds, which allows the banks to widen its lending parameters to give you a better deal.
Who can get an FHA loan?
From a financial standpoint, FHA loans are among the easiest to secure. As long as you have a credible work history, a credit score above 580, sufficient monthly income to meet FHA’s debt-to-income requirements, and at least 3.5% of the purchase price to put towards a down payment, you can qualify.
Who can’t get an FHA loan?
The FHA loan program was designed primarily to motivate residential home ownership. For that reason, FHA won’t back a loan for commercial property investments, which would include any multifamily property with 5 or more units.
Moreover, FHA requires purchasers to establish occupancy within 60 days of closing and maintain primary occupancy of the property for at least one year. While it is possible to open up a second FHA loan on a future property, you’ll have to give your lender a convincing reason (family growth, job relocation, etc.) to approve it.
So, where does that leave a multifamily real estate investor?
I wouldn’t rule out FHA just because of its occupancy restriction and ban on commercial property. I’ve known plenty of multifamily investors to build a firm foundation by using FHA to purchase their first small multiplex, live in one of the units for the first year, and grow their business from there.
Deciding If an FHA Loan is Right For Your Investment Business
Why would you want to consider an FHA loan? Here are several good reasons:
- More Affordable Down Payment – With FHA, you can get away with a minimum down payment of 3.5% of the purchase price. That’s far lower than the 10-20% you’d pay on a conventional loan. Additionally, there are down payment grant programs available that could lower your down payment to 0%.
- Lower Rates – Because of their government backing, the base rate on FHA loans is typically lower than what you’d find on a conventional loan. Needless to say, lower rates make for cheaper mortgage payments and better cash flow.
- Looser Credit Requirements – This is one of the main benefits of an FHA loan. Just be warned, lower credit scores tend to fetch higher interest rates.
- Seller Concessions – In most cases, FHA allows sellers to contribute up to 6% of the purchase price towards your closing costs, prepaid expenses, discount points, and title expenses. This is especially valuable for investors who want (or need) to minimize out-of-pocket costs as much as possible.
- Assumability – This valuable benefit often goes overlooked. Let’s say you take out an FHA loan today at 4%. Now imagine, 10 years down the road, we find interest rates at around 7 or 8%. If you decide to sell at that time, you can offer buyers the option to assume your loan at 4% rather than the current market rate. That’ll give you a huge competitive advantage against other sellers.
These advantages add up to a fairly compelling case for FHA. But, that’s not the whole story. Let’s look at a few of FHA’s disadvantages:
- Upfront Mortgage Insurance Premium (MIP) – If you put down less than 20% on an FHA loan, you’re going to have to pay an additional 1.5% of your purchase price to help insure the lender’s interests against default. This fee will be added to your total loan amount at closing.
- Monthly Private Mortgage Insurance (PMI) – In addition to MIP, you’ll have to pay monthly PMI on any FHA loan originated with a loan-to-value ratio (LTV) lower than 80%. Depending on the purchase price and the amount you put down, annual PMI can range from .45% up to 1.05% of the loan amount. FHA used to knock out the PMI once you hit 78%. But now, if you put down less than 10%, it will stick with you until you either pay off the loan or refinance.
- Property Condition Requirements – To insure your loan, FHA requires that the property meet their minimum standards for safety, security, and soundness. In the event of a foreclosure, the government doesn’t want to be stuck with a dump. This requires a FHA-approved appraiser to evaluate the property and, if necessary, require additional repairs before closing. That process in itself can lead to forced renegotiations on repairs, closing delays, and headaches all around.
My Closing Recommendation
I want to commend the FHA loan as a strong option for investors just starting out in the multifamily investment business. If your family situation allows it, I wouldn’t be put off by the occupancy requirement. Purchasing a plex and living in one of the units is a fantastic way to learn how to own and manage a multifamily.
My biggest piece of advice would be this: purchase a property that’s going to give you stable, reliable cash flow even with the additional monthly PMI expense. When you do, move in and start adding value right away. As soon as you can get your LTV up to 80%, make sure to refinance and get rid of that monthly PMI so that you can increase cash flow.
What Every Landlord Needs to Know about
Rent Control, Eviction, and Anti-Discrimination Laws
The landlord/tenant relationship seems simple enough: “We sign a lease. I give you keys. You give me rent.” Unfortunately, there’s a lot more to it than that.
The history of tension between landlords and tenants in this country has contributed to a developing menu of laws meant to regulate the rental market. Most of the time, these laws heavily favor tenants over landlords. That means it’s up to us to know the law so that we can observe our tenants’ rights and protect ourselves in the process.
Today, I want to talk about three of the most important areas of law that apply to landlords: rent control, eviction, and anti-discrimination.
A Quick Note About Lawyers
I’m going to give you enough information to get started on your own legal research. That said, I’m not a lawyer. I highly recommend you find a local real estate attorney. They can help you navigate these issues more carefully than anything you find on the internet.
The history of rent control traces its origins to the early 20th century when public outcry against rent-profiteering seemed to be at its height. Over the last century, these laws have evolved in various ways to keep landlords from taking advantage of their tenants.
Rent control laws typically regulate the following:
- How Much, and How Often You Can Increase Rent
- Services You Can Withhold from Tenants
- Methods and Procedures for Adjudicating Disputes About Rent
- Acceptable Grounds for Eviction (see below)
Thanks to a Supreme Court ruling in 1924, the federal government has left rent control up to states and cities to decide for themselves. The upside of that is that Washington, D.C. doesn’t get to tell landlords in Atlanta, GA what they can do with their rents.
There is a minor downside, however, in that every landlord needs to track down and study the rent control laws (if applicable) that govern his or her market.
Thankfully, Landlord.com has compiled a helpful chart with links to everything you need to know for your state and municipality. You can find it here.
Like rent control laws, the rules that govern the eviction process are determined by each local jurisdiction. These laws can be quite detailed, spelling out the exact process needed to serve a tenant an eviction notice properly.
Generally speaking, there are three types of termination notice a landlord can serve:
- Pay Rent or Quit – The tenant is given a certain number of days to pay overdue rent, or they must vacate the property.
- Cure or Quit – Similar to the previous notice, but reserved for lease-violations that don’t relate specifically to rent (noise complaints, occupancy violations, etc.).
- Unconditional Quit – As the name implies, this notice gives the tenant no recourse. It’s usually served in response to some form of breach, repeated late rent payments, and/or severe damage to the property.
If the tenant fails to comply, the next step is to file a lawsuit to have them evicted. As long as the tenant doesn’t put up a fight, this process can be completed in less than a month. If, however, they decide to challenge the eviction in court, things can take much longer.
As you wait for judgment, do keep up utility payments and do not remove the tenant’s personal property. Trying to lock or freeze out a tenant will hurt your case in court and expose you to a world of legal liability, including charges of trespass and wrongful eviction.
If the court rules in your favor, you’ll be required to make contact with local law enforcement. It’s their job to serve and enforce the eviction order. Once the tenant is gone, you’ll have to follow additional state guidelines for storage or disposal of any remaining personal property.
Discrimination is one of the thorniest social issues in our society today. For landlords especially, even the slightest hint of impropriety will be enough to land you in a courtroom.
That’s why it’s vital that you internalize the following lists of protected classes. Review your screening and application process regularly to make sure you’re not discriminating against any of them in any way.
Federally Protected Classes
Under the Fair Housing Act, a landlord may not refuse a tenant based on any of the following reasons:
- National Origin
- Disability or Handicap (Physical or Mental)
- Sex (Gender)
- Family Status
Further State Regulation
Many states in the union have determined that federal protections don’t go far enough and have voted to expand upon them. California, for example, adds the following classes:
- Sexual Orientation
- Gender Identity and/or Expression
- Genetic Information
- Marital Status
- Source of Income
A Warning About Professional Scammers
I’m sorry to say there are people out there who make their living by baiting landlords into discrimination and then suing for damages. Don’t fall victim to these scammers. Protect yourself by knowing the law and reviewing your policies regularly.
In this post, we’ve looked at the three most important areas of rental law for landlords: rent control, eviction, and anti-discrimination. As we’ve seen, each area has its own particular concerns.
This may seem like a lot to keep track of, but with a little bit of research and a conversation or two with your lawyer, you can easily run a profitable business without violating anyone’s rights under the law.
The 10 – Step Quick Start to Multifamily Investing
Small Multifamily (2 – 30 units) is a niche with little competition that’s ripe with opportunities. The majority of the owners of these size properties are mom and pops, which often means below market rents, value add potential, and seller financing possibilities. Don’t overlook these small properties! Follow the quick 10-step plan below to take one down and start building Life Time Cash Flow!
- Evaluate personal finances.
Before you start looking for deals, you should do a self-evaluation of your current financial situation. Do you have money to invest or do you need investors? Can you qualify for an FHA loan? How about an income property mortgage or commercial mortgage? What can you do to improve personal finances?
- Identify if you want to focus on residential 2 – 4 units, or a small commercial property, 5 – 30 units.
You can clearly focus on both, but it’s important to know that there are a variety of differences between residential and commercial multifamily. If you’re interested in “house hacking” or FHA loans, you’ll need to focus on residential. There are many other differences as well such as the loan process, balloon payments, and even your exit strategy options.
- Determine where you will focus.
There are 2.25 million multifamily properties in the U.S, and you can’t chase all of them. When selecting your market area, focus on four things: employment and job growth, income growth, population growth, and multiple large employers.
- Connect with a local agent/broker and a local banker.
As you know, the journey to Lifetime Cash Flow is not one you take alone. Two of the most important team members you will need include a motivated and active agent/broker that focuses on multifamily, and a local banker that you’ve discussed loan options with and/or have a relationship with. The first team member will help you find deals, and the second will help you take them down.
- Start to build relationships with potential investors.
Whether you think you need investors or not, I recommend starting to build those relationships. Remember, you are building relationships, don’t just talk real estate! They key is to find commonality and build strong and sometimes lifelong relationships.
- Become professional.
One of the most common mistakes new investors make is treating their multifamily endeavors as a hobby, not a business. Don’t go and form an LLC yet, but spend a few bucks and order yourself some business cards, a basic website off of Fiverr.com, and a free business phone number via Google Voice.
- Buy or build your property and owner database.
Having a properly built property and owner database is worth its’ weight in gold. This will be a vital resource for direct mail marketing, cold calls, and overall knowledge of the area. You download records from your county assessor websites and you can build your list in Excel or use a free or low cost CRM.
- Get that first direct mail campaign out the door!
Direct mail is one of the best strategies to find off market deals for any type/size of real estate, especially small multifamily. As stated above, a lot of these owners are older moms and pops, and you’re not going to reach them via Facebook or PPC ads. I recently interviewed a young couple in Houston that took my advice and mailed 300 letters and just closed on a 36 unit property which will ultimately net them 10k per month.
- Implement other marketing strategies.
Don’t put all of your marketing eggs in one basket! Implement other strategies as well to ensure you have a consistent deal flow. Utilize auctions, driving for dollars, Craigslist, and the dozens of other ways you can find great off market deals.
- Practice, practice, practice analyzing deals.
When it comes to small multifamily you need to become an expert at analyzing both residential and commercial deals. You need to know that 2 – 4 unit properties are valued based on comparable sales, and that 5 unit and up properties are based on the NOI and Cap Rate. The only way to become great at analyzing deals is to practice! Spend time everyday reviewing deals and kicking the tires. Practice, practice, practice!
On Finding the “Perfect” Deal
Leo Tolstoy once wrote, “If you look for perfection, you’ll never be content.” On one level, that might sound defeatist: “You’ll never be perfect, so why even try?” On the other hand, Tolstoy’ might just have offered a wise insight for real estate investment.
I’ve heard plenty of would-be investors go on about finding the “perfect” deal. Sometimes the word’s used as an excuse to rationalize poor decision-making: the “perfect” deal is whatever deal they happened to run across last week. Sometimes it stops people from taking any action whatsoever. Other times, it’s used to justify inaction: “I’ll never find the perfect deal, so I might as well stay home.”
Here’s what it all comes down to: there is no such thing as the “perfect” deal, only deals that more or less conform to your idea of a successful acquisition. Put simply, you get to decide what “perfect” means when it comes to buying real estate.
But, how do you do that?
Set Investment Criteria
Investment criteria are the parameters you’ll use to flesh out your idea of the “perfect” deal. Without investment criteria, you are shooting with a shotgun instead of a rifle. In this business you cannot be all things to all people. You must focus to be taken seriously by brokers, investors and lenders. In what follows, I’m going to walk you through some of the most important criteria you need to consider before you start looking for deals.
Keep in mind: In ways that will become clear as we go along, these categories all feed into one another. As you get to know your market, be prepared to fine tune as you go.
Where do you plan to look for multifamily properties? It’s always best to focus on markets you know firsthand rather than those that seem interesting.
Here are four markets to consider first:
- Backyard –Looking for properties in a market in or near your current place of residence offers some significant advantages: firsthand knowledge of the real estate market, “insider” information on the best locations, ability to see properties in person, and hands-on management are just a few.
- Hometown – When it comes to analyzing a market, familiarity with the terrain is incredibly valuable. While you may be long removed from your hometown, you’ve probably held on to a strong intuitive sense of how the market and the area work. If you have family in the area, they can help you as well.
- Boots on the Ground – Speaking of family in the area, it’s a great idea to look for multifamily investment properties in markets where you have close, trusted friends and associates. With these representatives in place, you’ll have the local support you need to find and service properties in those areas.
- Retirement/Vacation Destination – If you already own a vacation home or are planning to spend your retirement in a particular location, then why not add that market to your list? You’ve already gotten acquainted with it through travel and or market research for your retirement/vacation home. Moreover, when the time does come to retire, you’ll have easy in-person access to your portfolio.
- If None of these Areas work – Draw a circle the equivalent of a 2 hour drive around your home and look there. You can easily find and manage property that close to your home.
How many units are you looking for? For a newer investor, you may want to start with a smaller “residential” multifamily property (2-4 units) to help you learn the ropes. Residential multifamily is less threatening and the mistakes are smaller. Over time, however, you’ll find it difficult to scale your business with smaller properties. At that point, you can advance to larger commercial multifamily properties (5 plus units). You’ll find they are the same amount of work to purchase as the smaller residential multifamily properties.
What type of property are you looking for?
- Class A – Premier and luxury properties fall into this category. They’re situated in prime locations and are usually among the newest properties in a market. You’ll pay a premium, but high rent, stable tenants, and low vacancy make Class A properties a worthwhile investment and the investment of choice for institutional investors. From a value perspective, these properties will normally appreciate at a high rate. Rental growth, on the other hand, can be slow and cash flow margins slim.
- Class B – Better suited to middle-income residents, these properties aren’t quite as new and exciting as their higher-end counterparts. They have some mid-level amenities, but nothing as posh as Class A. These properties may not be highly placed, but they do offer more opportunity for forced appreciation and rental growth. For that reason, the Class B market can be highly competitive.
- Class C – Properties are 30-50 years old and offer little (if anything) in way of amenities. They can be located in stable or declining areas. Those factors make Class C properties more affordable and easier to rent. The relative lack of stability in tenants, however, will make it harder to maintain high occupancy rates. The great advantage of these properties is that they offer plenty of opportunities for investors to improve the property and grow rental rates. (value add)
- Class D – As you could imagine, these properties lie at the low end of the spectrum. They’re often old, rundown, and located in the worst parts of town. The advantage of Class D properties is that they’re cheap and offer substantial cash flow. Managing tenants, however, can be incredibly time-consuming. Defaults will be common, turnover will be high, and you may end up spending more of your of time dealing with various management headaches than anything else. These properties are a cash flow play only.
Closely related to the type of property is its level of stability. On one end of the spectrum, you can purchase a relatively turn-key multifamily rental investment (stabilized). On the other end, you’ll find the proverbial clean slate (fully vacant).
- Stabilized – The property condition is solid, occupancy is reasonably high, and rental rates are in line with the market. So long as your numbers add up and cash flow is strong, there won’t be much for you to do to this property after closing.
- Value Add – Perhaps the property could use some updating, and rental rates could be bumped up to get them in line. This type will require more work and capital than a stabilized property, but the potential reward will be greater.
- Occupancy Less than 80% – Like the value add, this property will require more work from you than a stabilized property. At a relatively low rental rate, you’ll be taking on an additional risk which may also complicate your ability to secure funding. Nevertheless, with added risk comes added reward.
- Fully Vacant – Vacant properties are challenging in that you may have to go several months or longer with no income—forcing you to cover the mortgage bill yourself. Still, if you can buy a vacant property for the right price and renovate it to match current market standards, you’ll likely recoup those lost months and more in forced appreciation and increased rents. Important to know why it was vacant to begin with.
Your price range will have to consider a number of factors: the market you’ve chosen, the types of properties you’d like to pursue, the size of those properties, and so on.
Of course, all of that depends on how much funding you can get your hands on. If you’re planning to secure a conventional loan on a residential multifamily property, speak with a lender as soon as possible to obtain pre-approval. If you’re going after larger properties, secure your equity funding and lending sources before/during your search.
How involved do you want to be with your property?
- If you’re just getting started in your investment career and you’d like to handle all of the management yourself, then you may opt for a smaller-sized, higher-class property. If you try to self-manage a Class D property, you just might bounce yourself right out of the business. I have owned and managed D properties and I do not recommend them.
- If you’re planning to hire an on-site manager, this can be accomplished on just about any sized property. The larger properties will require a full time person with a salary, but even a property as small as a duplex can allow you to give one of the residents a small rent credit to keep an eye on things, pick up trash and show empty units.
- Working with a management company is prudent if you don’t have the time to deal with it, or you’re in full acquisition mode. If you listen to my podcast, you are likely aware that I am a proponent for self- management whenever possible and certainly once you have enough of an infrastructure to support it.
There are no “perfect” deals out there, but the more carefully you define your criteria, the more likely you’ll be to find the perfect deal for you.
These are the categories I’ve found to be the most important when setting out investment criteria. You may prioritize them in different ways or even add your own (you might care about aesthetics, for example).
What matters most is that you define your criteria as clearly as possible. Revisit them regularly to make sure they align with the realities of the market, your comfort level, and your goals. As you grow into this business, expect your criteria to grow with you.