First I learned the rules of the investing game, then I learned the rules of brokerage. Finally, I applied the rules of brokerage to investing. It’s a different set of rules. You can’t go about investing the same way you go about buying or selling your own personal home. It doesn’t work. Those are two different processes, and the rules of engagement are 180 degrees different.
Now I work with investors on a broader scale, and we’re not focusing so much on REOs because that’s not where the economy is right now. Instead we’re focusing on occupied, multi-unit rental properties—properties that are already up and running.
In this market banks don’t like it when you come to them and say, “Hey, I got this great project. It’s a real dump, but I’m going to fix it up. In six months, it’ll be cash flowing.”No, no, no. Banks want to see cash flow today. They want to see cash in your pocket, the day you close. I’m going to show you how to do that.
As our government tried to step in and save the day, short sales became the mainstay of a lot of investors and real estate agents. I have to admit, short sales now are going much better than they used to. A short sale is laymen’s terms for properties that are technically in default but have not yet gone through foreclosure. As of this writing there are still a lot of short sale properties in inventory. More in some areas, less in others! When our government twisted the bankers’ collective arms to not foreclose as often, the answer was the short sale.
It used to be a horrible activity to engage in. Short sales were taking well over a year to get closed. You know, the asset managers managing the properties, they would change file services like you and I change underwear, and every time they did that, you’d have to start all over again. It was ridiculous!
Banks would also at the last minute force real estate agents to take less on their commission before the bank would cooperate on the sale, even when the agent had a contractual agreement with the owner of the house for a specific percentage. In all of their unethical glory, banks would go as far as to say that if the agent didn’t cooperate they would blame the failed sale on the agent for being greedy. Many distressed homeowners gave up during the short sale process because it was easier to just walk away and allow the foreclosure to happen.
After a few years of pain and agony the banks finally began to improve on their short sale processing. It’s far from perfect but it is better. Short sale means that a person is falling short on their ability to pay their loan, and the bank is going to allow you to step in and save the day and buy the property before it goes into foreclosure.
Finally, things started changing the last several years. Not so many short sales in some parts of the country, but other parts there are lots of short sales. Again, like in Hampton Roads, Virginia, lots of short sales, lots of them in Texas and Georgia. Now there are intermediaries who step in,typically attorneys who help the process go much more smoothly.
What is usually a little bit easier than short sales but sometimes frustrating is an estate sale.
Estate sales come about as the result of the homeowner dying and leaving real property to their heirs. If there isn’t a spouse still alive then ownership usually passes to sibling children. More often than not the children at first see dollar signs and are hopeful for a windfall. The reality is that the home they inherited is usually old and in need of a variety of repairs, systems upgrades and just downright remodeling.
The siblings get discouraged because the house didn’t sell at their unrealistic high-priced expectations and they are now suffering through repeated price drops. They begin to argue and no one wants to cooperate by forking over money to improve their childhood home.
Then all of a sudden they get hit with a tax bill, a water bill, a sewage bill, and they get tired of fighting over who’s going to pay it. So, here comes the investor dressed in shiny amour and galloping onto the scene on a handsome white horse. Yeah, right. The sons and daughters of the deceased parent have been forewarned about us. Trust me. Most realtors don’t understand us (even though they say they do) and so they have painted a not-too-appealing picture of us to their clients. All this does is hinder progress.
To an investor, this is a business transaction, nothing personal. The bottom line is that the current owners have a problem and the investor has the solution. If the projected return on investment isn’t suitable to the investor he/she will move on. He/she is taking on a lot of risk and requires a profit that compensates for spending time, energy and money on the project—and of course assuming the risks that go along with this type of investment.
At the end of the day, if you as the investor can put up with a lot of emotional baggage from the grown children who are tasked with liquidating their parents’ home, you can usually make a tidy profit on these properties. These people are “don’t wanter’s” and we are helping them offload what they don’t want.
Another type of “don’t wanter” is the retiring real estate investor. At the end of every real estate investing career—successful or not—is a property owner who wants to liquidate.
I’ve bought lots of properties from retiring investors. I actually like working with them, even though you might think, “I’m not going to get a grand slam deal with these guys because they’re investors. They know what’s going on.”Well, guess what? Because they’re investors, usually they will price their properties more reasonably. They understand what they’re worth.
They know what good investors—investors who’ve been trained and educated—are looking for. They know we’re not looking to be fooled or misled or misguided, and given a bunch of hypothetical projections. We want actual data. We’ll make our own projections. Give us the data, and we’ll tell you what we think the building is going to do in the future.
But in any case, these investors are liquidating properties because they’re retiring, some through divorce, others because they’ve owned them so long, they depreciated them, and now they’re selling. Maybe they’ve become ill.
One of them, Mr. Pflugfelder, taught me there’s basically a seven-year rule with investors. That is, on average, every seven years you’re going to hit a slump with your properties. Maybe not all at the same time, of course, but sometime you’ll have slew of major upgrades that have to be done: roofing, furnaces, plumbing, electrical. Maybe your properties haven’t been renovated in so long, or you’re far behind on your rental rates, and you need to get people out to remodel and raise your rates.
That can be a painful process because while you’re doing that, you’re typically not bringing in income. You’ve got money going out but not coming in. One of the biggest things is to learn to stick it out through the tough times, if you’ve invested properly, if you have the right ratios. Remember you should maintain a two-thirds to one-third debt ratio. If you own a million dollars in real estate, you should not owe more than $666,000.
Now, that’s an average. While you’re actively and aggressively growing your portfolio, it’s okay to be leveraged up to 75%, even 80% in a market like we have today. Eventually, you will get it to 65% just by paying down mortgages and raising your rents.By increasing the value of your buildings by making improvements, you should be able to do that in short order. On the income/expense side, you don’t want to owe (the principal and interest of all loans) more than one-third of the rental income that you bring in.
That doesn’t include taxes and insurance, though. Taxes and insurance are an expense. Interest, of course, is an expense, too. But in any case, if you’re making $10,000 in rent per month, your debt service—your principal interest portion of your debt service—on your mortgages, should not be more than $3,300.
If you follow and abide by these two guidelines, you will always be successful. I promise you, you’ll make it through the thick and thin times. You’ll make it through the tough times, if you follow those guidelines.
An example of tough times is what happened in Western Pennsylvania after the massive flooding in 2004, when a couple of hurricanes decided to get together and throw a party. It flooded a lot of properties, including some of mine. I had 12 units out of service, about one-fifth of my portfolio at the time, literally under water.
But you know what? I was still okay. I made it through because I had managed my ratios. I had managed my income/expense ratio, and I managed my asset/liability ratio, and I was able to make it through those tough couple of weeks to couple of months.In fact, I got most of my tenants back because I worked hard to get the units back up and running. I helped those people personally, and as a result I had friends for life.
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