Investing in Real Estate 101

CHAPTER SIX:

Step Two

 

O.K.  Now, where do you want to invest?  I suggest that you stray no further than 60 miles from your home.  It becomes easier to manage your investment from this distance.  To keep costs to a minimum I suggest that you do your own property management, which is not too difficult to master.  (Advertising, signs, forms, credit checks.)

Find your target area, then refine your search to a specific neighborhood, and then become an expert in that area.  You should know as much or more than the local "Neighborhood Agent".  The more you know about your neighborhood, the more successful you will become.

1. How old is your target area?
1. You should consider age and remember that new properties tend to appreciate more than older neighborhoods, but that is not always the case.  Do your homework.
2. What is the condition of the complex?
1. Amenities

                                                   i.     Pools

                                                 ii.     Clubhouses

                                               iii.     RV storage

2. Homeowners Association

                                                   i.     Reserve Study (Reserves are the live blood of the homeowners association.  Without reserves, the Association will ask you, at some point in your ownership, to come up with a special assessment to replace or repair a major component.)

                                                 ii.     Special Assessments (Read the minutes of the homeowners association for at least one year to determine if they levied or talked about any special assessments.  Also contact the Property Manager and determine if there are any anticipated for the future.)

                                               iii.     Any restrictions on rental activities?  (Although rare, you must also read the Associations Rules and Regulations to determine if there are any restrictions or additional monthly charges for renting out your unit.)

3. What is the makeup of the community?
1. Is it an ethnic neighborhood?

                                                   i.     Do you speak the language and have an opportunity to rent your unit easier than most?

2. Is it a restricted neighborhood?  (Senior Community)
3. What are the local rents?
1. This is extremely important to your success and you must determine the accuracy of this number through various sources.

                                                   i.     Local newspaper rental ads.

                                                 ii.     Real Estate Agent (MLS Listings)

                                               iii.     Drive by the complex and call on for Rent Signs.

                                                iv.     Online rental sites.

5. Tenants
1. Repairs – Remember that tenants are "hard" on your components, but you must draw the line on "normal" wear and tear as opposed to willful or negligent "destruction" of your property.
2. Deposits – You should get at least the amount of the first months rent.  In my areas, I usually obtain less, because of the renters' inability to come up with more than that.
3. 3-day letters – The 3-day letter serves as legal notice for your tenant to pay his/her rent or move out.  If you have chronic problems with tenants paying late, you might use this tool to get them back in line as well as late charges.  I find this hard to believe, but I have tenant who pay late charges every other month without question.  They just choose to do so to make ends meet.
4. Eviction – Try to avoid this at all costs, including "cash for keys" which is, "If you move out by this weekend, I will pay you $500.00 to get out!"  If you have to go through the eviction process, you can handle this yourself, as well, or hire an eviction attorney.  Go to your local Superior Court website and look up "unlawful detainer" process.  The online forms will walk you through the process of filing the legal paperwork necessary and serving the forms on the tenant.  A professional for around $1000-$1500.00 can also do this.  It can take about 30-45 days for the process to complete, if the tenant does not fight the process.  Worst-case scenario, if the tenant files the process, files for bankruptcy, they can possibly live in your property rent-free for one year.  Best hire an attorney for advice at this point.
5. Smoke Detectors – Have them in each bedroom, hallway, and near the kitchen.  Make sure your tenants sign that they are in good working order.
6. Section 8 housing – Within the last few years I knew of, but just began using Section 8 housing.  It is a County service provided to low to no income individuals who qualify.  This is the new Section 8 and not the old horror stories of the past.  The clients, for example, pay $200 of my $1200 monthly rental payment.  The County pays the remainder, every month, and directly into my checking account.  The clients are well mannered, respectful, and thankful for what they are getting.  The County conducts a formal inspection of your unit to make sure that everything is working and in good order.  The inspection is semi-formal with a county worker filling out pre-made forms.  The County will also tell you what they will pay monthly for your rental.  Therefore, if you expect and think you can get more than they are offering, then you can provide three rental units in the area that are getting more, or not use their services.  I would recommend this approach as a source of renters. 
6. Writing an offer (The Real Estate Contract)
1. Initial down payment should be between $3-$5K.  The more you offer, the more you have at risk, maybe…  If you want to impress the seller your can offer $10, $15, or $25K.
2. Your financing should be in place.  10-20% down and include the pre-qualification or approval letter with your offer.  The agent may also ask for your FICO scores and proof of funds.
3. Who pays what?  Buyer and seller customarily share escrow and title equally.  The seller should pay all other costs, but everything is negotiable in a real estate transaction.  What I tell my clients is that everything comes down to the bottom line.  You may offer full price or more for the home, and then ask for a credit of $5K in the transaction.  What is your price really?  Its $5K less than full price to the seller and not a "full price" offer.
4. Contingency periods are normally 17 days, but again may be reduced or increased.  If you are a buyer, have your agent mark the box in the financing area to extend the financing contingency period until just prior to closing of the transaction to provide you with the most protection.
5. Contingency periods – This is the "Free" period in the transaction where your initial deposit in NOT at risk.  You can back out of any transaction before the end of this period without jeopardizing your initial deposit.  If you are a buyer, then you want this period to be the longest, if you are a seller, then you want this period to be the shortest.

                                                   i.     Financing – Anything agreed to, but can include all the way to "loan funding" on the last day of escrow.  What this means to the buyer is that if you cannot get a loan for whatever reason, you do NOT loose your deposit.  If you were a seller, then you would want this contingency removed as soon as possible.

                                                 ii.     Inspection – Again, same as above.

                                               iii.     Disclosures – This is the area where the seller will tell you everything of "material fact" they know about the property.  If the seller tells you that the hillside behind their home is slipping, run fast.  Other disclosures may include a death in the property, water damage, major component repairs, etc.  This is your notification of those facts and it is your decision as to whether you want to complete the transaction of back out.

 

Now its time to put all the knowledge you obtained to evaluate your neighborhood to see if it is a good investment area.  The one thing you will find is that its ALL about PRICE, BEDROOMS, & RENTS.  With these three bits of information, you can make a quick determination if this is where you want to invest.

 

          PRICE:  Like purchasing a stock from the stock market, determine the price history of your neighborhood.  I want you to research as far back as when the unit was built and chart out your results.  Real Estate is a cyclical market with its ups and downs like a stock.  The market is somewhat slower than the AT&T stock you might own, but it goes up and down just the same. 

What is a good price?  Real Estate Agents will tell you a "good price" is what a "willing buyer and seller agree to pay for a home".  As an investor, a "good price" is what YOU, are willing to pay after completing all your homework and working your numbers.  If you are in a "down" market then you need to "guess" where the bottom of the market is.  However, working your numbers should provide you "piece of mind" that if your purchase does continue to decline, that you are in a "positive cash flow position".

Positive cash flow.  How much is enough?  A good rule of thumb is a minimum of one month's rent.  For example if your rent is $1200.00 a month, then your positive cash flow should be $100.00 a month.  However, my rule of thumb is at least $300.00 or more per month right now. 

          In a "down" market, you should invest like a "long term" investor.  Knowing that real estate is a cyclical market, buy a home with positive cash flow and then wait for the market to turn positive.  Once the market is positive then you can worry about continuing to be a landlord, cashing in, or trading up.

          Now its time for an example…  Around 1981 I purchased my first condominium for $54,000.  The tenant was in place and the place was filthy.  My new wife called me crazy, but she feels better now that it is paid for.  The point of this example is that the price of this condominium rose to $112,000, more than double in price and I was on top of the world.  I decided to hold onto the condominium and saw the price plummet back down to $60,000 before the next increase in the market to $200,000.  The market leveled off for many years before taking off in this last upturn to approximately $450,000.  With this most recent downturn this condominium is now worth around $200,000 again and dropping.  However, what I can be thankful for in my planning is that the rental market has done nothing but increase and I have been in a positive cash flow situation since the beginning.  Knowing all along that my renter is paying for my purchase and creating me income and equity.

 

          BEDROOMS & RENTS:  Remember, a one bedroom is rentable, but can be difficult to sell.  When you purchase your home, you should also be looking at your future ability to sell the investment.  Two and three bedrooms are easier to rent, but you also have to be wary of overcrowding.  The difference in rental prices is currently about $200-$300 per bedroom, in my market.  In my farm area, a one bedroom rents for $1200, a two bedroom for $1600, and a three bedroom from$1800-1900 per month.  My rental market is extremely "hot" right now and has been for many years.  It takes me less than one week to rent out my unit with just a "For Rent" sign placed in the window.  I have renters calling for weeks after still asking if it is for rent, after I rent it.  I hold firm on my rental asking price for this reason, because "yes" they do ask for a rent reduction when you meet them.  Why not, all you can tell them is "No."