Is Debt Really That Bad? Utilizing Debt vs. Equity
If you’ve already purchased investment property, you may already have some knowledge about the information presented in this article. Although I go fairly deep, you could skip this one if you like. If you have never owned investment property, this information will definitely add value to you.
“Debt is bad” or so we have been taught. Over and over again it has been pounded into our heads to reduce debt; get rid of credit cards, buy with cash, not credit and so on.
But is all debt really that bad? No!
Can debt actually build wealth? Yes!
First, let’s clarify that personal debt, such as credit card debt, or a home equity line of credit that is used to pay for personal expenses is almost always considered detrimental to your financial health. However, debt which follows the acquisition of an income producing property can actually help you build wealth.
Leverage, the term used for debt financing
Leverage, the term used for debt financing, is an important part of most real estate deals. Using leverage to purchase an income producing property can increase your Cash on Cash Returns. The key to understanding leverage is knowing how much to use and when.
Looking back on the 2008-2009 downturn, it is clear to see that there are times when too much leverage on an asset can create catastrophic losses. Thus it is key for us to understand leverage – to be familiar with the risks associated and know what level of leverage is prudent in a given situation.
Loan-to-value is another term used to describe the amount of debt (leverage) on a property in relation to its value. Just prior to the recession of 2008-2009 there were many five-year loans being issued with very high (85-90%) loan-to-value rates. Two key mistakes that we can see here – very high leverage (85-90% LTV) and loans based on peak property values. As we all know, when those notes came due and the property values had dropped, then the need to inject equity to keep those properties was impossible for many investors. A better strategy is to reduce leverage as the market gets “hotter” and to write longer terms loans (10-20 year balloons payments instead of 5 years) as prices become increasingly unsustainable. Thus when the inevitable correction comes, you are prepared to weather the storm, maintain your cash flow, and are at very little risk of ever losing the income generating asset you worked so hard to attain.
…compare two deals with different amounts of leverage…
As you look at deals, a great way to compare two deals with different amounts of leverage is to compare the Internal Rate of Return (IRR). For a little background, the internal rate of return (IRR) is a widely used investment performance measure in commercial real estate, yet it’s also widely misunderstood. Simply stated, the Internal rate of return (IRR) for an investment is the percentage rate earned on each dollar invested for each period it is invested. Ultimately, IRR gives an investor the means to compare alternative investments based on their yield.
For instance, if you have one deal that shows an IRR of 10% and has lower leverage while another shows a 14% IRR with higher leverage, you should ask yourself whether the additional risk (due to the higher leverage) is adequately compensated by the increased return. If not, the lower return may actually be the better return!
Use Debt to Increase Your Return on Investment
Let’s take a few moments to show you how using debt impacts return:
In this first example above, the investor spent $800,000 out-of-pocket to purchase this investment property (not including closing costs). He will receive a Net Operating Income (NOI) of $60,000 which results in a Cash on Cash Return of 7.5%.
Let’s now look at the return if he would have 25% equity in the property by utilizing debt:
In this example, the investor spent $200,000 out-of-pocket to purchase this investment property (not including closing costs). He financed the remaining $600,000. After paying the monthly mortgage payment, the investor will earn $17,826 annually. This creates a COC return of 8.9%. In addition to the higher return, when the investor used leverage or bank financing for the purchase, he still has $600,000 remaining to invest into additional income properties.
Imagine if he used the remaining $600,000 to invest into three additional income properties. Not only would his NOI probably be greater than the $60,000 in the previous example, but he would have four properties appreciating instead of just one.
Use Equity to Counterbalance Leverage
The strategic use of existing equity can also dramatically increase your return on your real estate investment. Over time, as the mortgage is paid down and market values increase, the equity in your investment properties will also increase. This equity can then be pulled out and used as the down payment on another investment. Once again you use leverage to increase your returns. As mentioned above it is prudent to maintain 25-30% equity in your property. Currently most lenders require this amount of equity as a precaution against repeating the harsh lessons of 2008-2009.
Remember, not all debt is bad. Stay away from personal debt but use investment debt to build your net worth, property portfolio, and increase your cash on cash returns. Then as retirement nears, focus on paying off all the debt and enjoy the multiple streams of Lifetime CashFlow!
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10 Steps to Your First Small Multifamily
Are you ready to purchase your first small Multifamily Property?
The small Multifamily real estate market (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 10-step plan below to take one down and start building Lifetime Cash Flow.
I’ve compiled this 10-step plan to help you start building Lifetime Cash Flow
1. 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?
2. 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.
3. 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.
4. 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.
5. 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.
6. 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 from Fiverr.com, and a free business phone number via Google Voice.
7. 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 can build your list in Excel or use a free or low-cost CRM.
8. 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 (Pay Per Click) ads.
I just interviewed a young couple in Houston who took my advice and mailed 300 letters and just closed on a 32-unit property which will net them $10K per month!
9. 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.
10. 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 every day reviewing deals and kicking the tires. Practice, practice, practice.
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12 Tips For Successful Networking + Checklist
Some people say the key to success in real estate investing is location, location, location! That’s true, but I tend to think it’s also network, network, network!
In any business, you need to network. In multifamily real estate, you absolutely need to network. Think of all the primary connections you need to have: sellers, investors, brokers, and lenders. Now think of all the secondary connections you need to have: attorneys, appraisers, title companies, mortgage brokers, and many more.
It’s impossible to be successful in real estate without a strong team.
The road to Lifetime Cash Flow is not one you take alone.
Many people say, “Well, I’m an introvert” or “I’m not a people person” or “Networking makes me uncomfortable.” But guess what? Greatness doesn’t happen in your comfort zone. Your success depends on how comfortable you can become with being uncomfortable. Bottom line… you need to get out there and network to become a success in multifamily.
In order to help you with your networking goals, we’ve put together a list of our Top 12 Multifamily Networking Tips. In addition, we’ve included a comprehensive “Multifamily Networking Checklist” at the link below.
1. Don’t just network anywhere
Focus on the right groups such as your local REIA’s and real estate Meetup groups. If there’s not a multifamily specific Meetup group, start one!
2. Develop a short elevator pitch and practice it!
Tailor this specifically to the event you’re going to, and what you’re hoping to achieve from it. People need to know what you do and/or what you’re looking for in just a couple of sentences.
3. When networking, remember you’re playing the long game.
Please don’t go trying to buy or sell when you first meet someone. You are building lifelong relationships. Multifamily real estate is a tight knit community and nobody likes the pushy first timer.
4. You need to add value.
What can you offer to help? What skill sets do you have that might add value? If someone is new to the area, tell him or her about the best restaurants. Your assistance does not have to be something huge. Just focus on adding value.
5. Focus on quality over quantity.
People will brag and say, “I met 50 people!” 5 deep quality connections are better than 50 that go nowhere.
6. Focus on receiving business cards
Not passing yours out. That way you’re in control and can reach out as soon as possible.
7. Research attendees before the event and be prepared
Know who you would like to meet and what you want to ask them. People are very flattered when you have some knowledge of their business. (google)
8. Develop and practice an “ice breaker” question, comment
Or create a statement that you are comfortable using and rehearse this with your spouse, friends, or family and become a master at it. My personal favorite is; walking up to someone with my hand outstretched to shake theirs and saying ‘I don’t think we’ve met…I’m Rod Khleif.”
9. Google yourself
Ensure that you have a professional online presence. Keep in mind that when people search your name after the event your social media profiles will typically show up before any personal/business websites. It might be time to clean up those personal profiles.
10. Focus on how you make other people feel
If you can make sure they’re having fun, enjoy speaking with you, and don’t feel awkward; they’ll surely remember you! Read the book; “How to Win Friends and Influence People.” One key is to ask people questions and let them speak.
11. Whenever possible, be a “connector.”
Whenever you’re speaking with someone, be thinking of anyone you know that might be able to add value to them. Focus on being an introducer and connecting people who can benefit one another. These introductions go a long way, in building relationships.
12. Follow the 6 steps in the “After the Event” Action Plan in the link below.
The absolute key to successful networking is your follow-up. Make calls, send emails, set up phone calls or meetings. You are developing relationships.
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.