Income Property Investing Secrets

How to get started

First I will give an overview of the steps then I will go into more detail about each step.

If you are a beginner in Real Estate Investing, education is the most important asset you can acquire. Your first step should be to search your area for an Apartment Associations and join the Association before you begin shopping for any investment properties. Your local Apartment Association will usually have forms, including leases, available for members to use for free. Some Apartment Associations put out monthly newsletters that may include the eviction schedule for your particular area. The second step is to decide if you will own these properties in your personal name or in a business name. You should ALWAYS consult an attorney and a tax professional for advice in this area. It is simple to set up an LLC (Limited Liability Company) which helps to protect your personal assets from possible lawsuits. Some people will bypass this step because it cost a few hundred dollars. You must decide how much your current assets are worth and if you should protect that investment too. You may realize certain tax advantages depending on how you hold the properties. The third step is to search the internet or real estate books to locate potential investment properties. A Realtor can help you to locate properties. If you chose to use a Realtor you should use a Realtor that also owns investment properties. The forth step is to evaluate the property for cash flow. This is the most important step and you may want to ask your banker to help you with this step until you are very familiar with the process. The fifth step is to place an offer on the property. The sixth step is to close on the property. The final step is to operate the property.

NEVER BLEED A PROPERTY!!! What do I mean by BLEED a property? You must reinvest a portion of the profits (rents) into improvements, NOT just maintenance and repairs.

Oakwood Apartments

This is one of three, 12 unit, apartment buildings we purchased in 2008 with NO MONEY DOWN. At the time, I made less than $50,000/year at a job and had a good credit score.

Step 1

Find an Apartment Association by searching the internet for this may not produce the result you are looking for. The quickest way to locate the nearest Apartment Association is to talk to a Landlord in the area you are planning to invest. If you are lucky, like I was, they will become your mentor. This is the fastest way to educate yourself. The process is simple, find someone that is already successfully doing what you want to do and copy everything they do and you will get the same results they are getting. Your local Realtor should also be able to help you locate the nearest Apartment Association.

Step 2

 

You may decide to skip this step, to be honest with you, we did at first. We later formed an LLC to place our properties into. However, we then realized extra cost in tax preparation because we have two completely separate rental businesses. (I would highly suggest you start an LLC to hold the properties. If you plan on purchasing only a few properties, it may be more practical to just hold the properties in your name, just be sure to have adequate insurance). Because we would be required to pay Real Estate taxes, to transfer the properties we are holding personally, into our LLC we are simply Leasing our properties to our LLC. Additionally, if you plan to purchase several properties you may want to start an LLC with LP’s under it. This arrangement will give you the most protection of your investments.  

NOTE: I am NOT an attorney or tax professional; you need to check with the laws in your state.

Step 3

This sound like an easy step, however, much time needs to be placed on this step. If the area you plan to invest in is a depressed area and further depression is expected then your rents will need to constantly be LOWERED to continue to attract Tenants. If you invest in an area where growth is expected then the demand for your apartments will become greater and greater and you will be able to increase your rents more rapidly. Note: this is where you will need to constantly be improving the property. Updating carpet, light fixtures, landscaping and keeping paint fresh is only a start. Depending on the age of the building remodeling of the bath and kitchen may be required. Once again, a Realtor would be able to tell you if property values are going up or down in a particular area.

Step 4

Evaluating a property for cash flow. This is a complex process however it can be reduced to a few simple steps to determine if you should even make an offer on the property. The methods I use are not scientific, first I take the total monthly rent and multiply it by 36 (3 years) then I take the total month rent and multiply it by 60 (5 years).

Example: A duplex where both units are rented for $400.00/month, the total monthly rent would be $800.00. If you multiply $800.00 x 36 months = $28,800.00. You then take the same $800.00 x 60 months = $48,000.00

It the asking price is in this range, or close enough that the seller may drop to this range, it is time to look at this property a little closer.

To fully evaluate the property you will need to have the following information:

1. Annual property taxes

2. Insurance

3. Utilities not paid by Tenant

4. Annual repairs & maintenance

5. Management fees

6. Lawn care

7. Snow removal in some areas

8. Advertising expense

9. Other expenses if any

Now take a sheet of paper and create two (2) columns, one labeled Income and the other labeled Expenses.

List all income, including rent, parking, coin operated laundry, etc. in the Income Column. Add this column and subtract 5% (The national average for vacancy calculation is 5%) Multiply this number by 12 to know the annual income for this property.

Now do the same for expenses and add the column. Usually this data will already be in an annual format and no additional math is required.

For the next step simply subtract the expenses from the income, this gives you the net income. If this is a negative number do NOT purchase the property, it is a negative cash flow property.

The final step is to see if this property is cash flow positive. For this you will need a mortgage calculator which can easily be found on the internet, I use http://www.bankrate.com/calculators.aspx . Simply enter the asking price, current interest rate and 20 year term. Note: Most banks will only lend for 20 years on investment property. You will need to divide your net income by 12 to get the monthly income. Now subtract the mortgage payment (debt service) from the monthly income and this is the cash flow. If it is a negative number enter a lower price. If it is a positive number, still offer a lower price.

Let’s use our duplex again as an example:

Let’s assume the asking price on this duplex is $80,000.00 at 6% interest rate your payments would be $573.14/month. This would clearly be a negative cash flow property.

(Now you can see why we established a range earlier by using the rent times 36 months and 60 months. That simple formula saves a lot of needless math).

However, if this was a $48,000 property then debt service would only be $343.89. This price is in our established range and provides a cash flow positive property.

This meets one other criteria I have, the rent, with one unit vacant, must make the mortgage payment

Your Banker may talk about CAP RATE. I am not going into detail about CAP RATE however my suggestion would be if the cap rate is below 5 do NOT buy the property. If the CAP RATE is above 10, make an offer immediately.

Step 5

 

Make an offer on the property. Everyone ALWAYS list the price on something for more than they really want. If you offer lower, the seller can counter offer, if you offer to low, they may not accept any other offer from you. You have done your homework and evaluated the property. You know the range you should be offering within. Take 10% - 15% off their asking price and make the offer.

Step 6

 

At closing be sure to have an Assignment of Leases. This simple document gives you the control of the current leases. The last thing you want to do is have the tenants enter into a new lease with you as soon as you purchase the property. This gives the potential for the property to go completely empty.

Final Step

 

Maintain the property. Make improvements between each tenant, you will be able to raise the rent for the new tenant coming in. If you do Not make improvements you will begin lowering your rents to attract tenants, and the process keeps snowballing downhill.

Paint is cheap, change toilet seats between tenants, be sure to change the locks too. Clean and shampoo carpets.

Attend to Tenant concerns promptly. We have a waiting list for our apartments because we follow a simple philosophy, would we live in the unit? If you can honestly answer yes, then you are ready to show the unit.

 

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