This is a great article written by my business partner Merrill Beyer III. Enjoy!
Did you miss our most recent Lehigh Valley Real Estate Investor Group Meeting?
No problem! I have summarized below what I had to say about the opportunities for realizing Hidden Profits.
But first, take a look at this un-hidden, very much in the open Real Estate Investment opportunity we at Significa are offering (go to www.significadeals.com for the details). Here are the highlights:
- $1,194/month Positive Cash Flow--that's after all expenses
- Off-Campus Student Housing for LaSalle University
- Located in the Germantown section of Philadelphia, it's a 3-Bedroom, 1-Bath, 1,084 sqft rowhome
For all the deals we currently have available in the Lehigh Valley, Wilkes-Barre/Scranton, and Harrisburg, please click on Significa Deals to check out our website.
Now back to how to find Hidden Profits.
In the current state of the Real Estate market with prices down significantly from their peaks AND mortgage interest rates at historically low levels, we at Significa are recommending to our clients a Buy-and-Hold strategy. Yes, flipping can be done profitably, even in this market, if properties are bought at the right price. But holding them until some point in the future when property values are again on the rise presents an opportunity for long term wealth accumulation.
So the assumption in what follows is that you are buying an investment property to hold and rent for passive income. To do this profitably, make use of the following common sense approaches to finding Hidden Profits in every deal you make:
- Never pay Retail prices, buy at Wholesale: This means buying distressed properties from motivated sellers. The market is already down some 30%, and with the current state of the economy and high unemployment, many homeowners are desperate to sell. This presents cash buyers with terrific opportunities to buy properties for 50 cents on the dollar. Sure, they need some renovation work to return them to full value, but that's maybe another 25 cents. Once the work is done, you'll now have a property that's practically better than new (more on this later), and all for a phenomenal discount. Compare this to buying a nice property that's in move-in condition at 100 cents on the dollar. For those who say they don't want to spend any money on repairs on a distressed property, consider that you'll need to put at least 20% down to get a mortgage on that nice-looking house. That's $20,000 on a $100,000 purchase. If anything breaks--you trusted that home inspector who spent one hour touring the property--where's the repair money going to come from now? You put it all into the down payment!
- Properly determining what to bid on the property: This is the most important part of the deal--not OVER-PAYING for the property. Pay too much and you end up trying to make it up in other areas, like the renovation, and that will just make matters worse. So bid wisely. But how do you know what price to bid? Do a market comparison. Unfortunately, most novice investors do this market comparison on similar distressed properties and figure out their bid accordingly. WRONG. The comparison should be done on recent sales of renovated properties or those in excellent condition (don't even look at listings or pendings, only the SOLD deals real buyers have put up real money for). Get help from a real estate professional--a realtor, an appraiser, or the Significa team--to come up with a conservative value that the property will be worth AFTER it's renovated. As a handy and very rough Rule-of-Thumb, once you've settled on a value, just cut that number into thirds: one third is the bid price, one third is the renovation cost, and one third is your profit. So if you come up with a value following the renovation of $90,000, pay no more than $30,000 to purchase the property. To negotiate to this price, offer a little less.
- Matching the Renovation Budget to the local market: Second to over-spending on the purchase price is over-spending on the renovation. Get help from experts in the market, like your real estate agent, contractor, property manager (or us), and tailor the scope of work and the quality of fit, finish, and materials to that market. This is where the Rule-of-Thumb might need to be modified: less on the renovation budget means the property is in better condition, so you can bid a little more on your offer to purchase. The reverse also applies--just be sure to protect your one-third profit! Keep in mind that you as the investor are not the primary customer of the renovation--the tenant and the appraiser are. The tenant is the one who will be paying you the rent that makes the investment work, and the appraiser will be setting the value of the renovated property that determines your mortgage. Since they're not around to tell you want they want, rely on their surrogates: the property manager and your real estate agent (four of us at Significa are licensed). They will protect you from yourself when you contemplate granite countertops for a HUD Section-8 tenant.
- Accounting for Exit Financing before the initial purchase: Don't wait until the renovation is completed and a tenant has moved in before applying for mortgage exit financing--start applying for a loan BEFORE you start looking for deals. Get pre-qualified from your bank or mortgage broker. Then do the math to figure out whether the rent (minus operating expenses like taxes, insurance, property management, and a repair and vacancy allowance) will cover at least 120% of the monthly mortgage payment. If not, then you'll end up either leaving a lot of your own cash in the deal or suffering a negative cash flow situation. Banks ARE lending. And at Significa, we know how to select properties that meet their strict lending guidelines.
- Items that can kill your Cash Flow: Do your homework in determining the operating expenses for the deal. The biggest killer of cash flow: property taxes. This is often the one item that can turn a good deal bad. Let's assume you find a deal that yields $200/month of positive cash flow that has $1,200/year of property taxes. Now take this same deal and change the taxes to $2,400/year: the additional $1,200 tax bill translates to $100/month less cash flow--one half of what you had before. Not good. High property taxes may disqualify an otherwise good deal. Another drag on cash flow: buying in a FEMA Flood Zone. The additional flood insurance premium can wreak havoc with your cash flow, so shy away from these locations unless you're getting significant cash flow to make up for it.
- Thinking of Tenants #2, #3, . . . : Preparing your rental property for Tenant #1 usually requires a thorough renovation. This is to be expected, of course, because the very reason we got the property at such a low price in the first place is precisely because of its poor condition. No problem--we're correcting all of those problems during the renovation. Your main concern is fixing anything that is likely to need repairs over the next 5 - 7 years. Things like the roof, plumbing, electrical, sewer, etc. Consider the cost as 'Repair Insurance.' Also important is how the choices made at this stage will affect the costs involved when Tenant #1 leaves and the unit is prepared for Tenant #2. These turn-over costs can be prohibitive if poor choices are made during the initial renovation. For example, if carpeting is installed on the first floor, it will be subjected to the kinds of severe punishment that can frequently render it unusable for the next tenant: dirty shoes from outside, food and drink spills, and pet soiling. So why put carpeting on the first floor if it will need to be replaced on every change of tenants? Stick with solid surfaces on the first floor. What kind? Tailor your choice based on the market, from painting the original floorboards at the lower end, to linoleum, laminate, and finally to Hardwood as you go more upscale.
- Focusing on Cost instead of Value: Now that I've got you oriented toward choosing lower quality features for the renovation, be careful about obsessing over cost. if spending too much for the property is the biggest mistake novice investors make, over-spending on the renovation is next. This is usually the result of an emotional attachment to the project, where choices are made based on what the novice investor likes for his own house rather than what is cost effective for a rental property. To do the renovation right, focus on value: how much does this feature add to the value of the property, to the amount of rent you will be able to collect, and to the long term durability of the property. If your contractor presents you with an item that adds $500 to the cost of the renovation, you might be inclined to reject it. But if it adds $2,000 in value, you would be wise to pay the extra $500. But if it only adds $300 in value, then it might not be such a good idea, everything else being equal. Keep the primary customers, the tenant and the appraiser, in mind as you make these decisions.
- Understand why Tenants move in: When you know this, you will be able to place tenants into your unit quickly. Assuming your property manager has priced the rent for your unit correctly, you will be competing against other units similar to yours. To win, first realize that 95% of your prospective tenants are female, either with children or a male husband/boyfriend in tow. Knowing what a woman wants will make you successful as a real estate investor (and in life). Pay special attention to the following:
-- Kitchens and Baths
-- Closets and Storage
-- Lead paint mitigation
-- Replacement windows (mitigates lead contamination, enhances energy efficiency)
-- Clean, Neat, and Sturdy
-- Location of the property
- Understand why Tenants move out: Once you've landed that good tenant into your unit, whether they stay or not for the full term of the lease will depend on the following:
-- Winter heating bills
-- Leaks from the roof or faulty plumbing
-- Deferred maintenance that is not addressed quickly
- Rent Add-ons: The advertised rent is just the beginning of the income you can make from your tenants. Be receptive and agreeable to their specific and unique requests, just add on additional fees. Here's some of the more common add-ons:
-- Security System
-- HUD Section-8
- Team-up with Professionals: There's a lot of talk about 'sweat equity' and the value of DIY (Do It Yourself), especially in this economy. TV shows highlight the ease and profitability of house flipping. Home Depot advertisements proclaim, "You can do it, we can help." When it comes to our own residences, that's fine. But when it comes to real estate investment property, DIY is a killer of profit. It takes longer, it's not professional, and it ultimately reduces the attractiveness of the finished product. We see the results of these failed projects all the time. If we buy one, the first thing we do is rip it all out and start over. With licensed, professional contractors, proper permits are pulled, the work is done right the first time, and their work is guaranteed. The DIY philosophy extends to other parts of the process as well: buying a For Sale by Owner (FSBO) to avoid real estate commissions, calling around for mortgage rates, not knowing who to use for title work, insurance, forming an LLC through an on-line service, etc. There are too many things that can go wrong when trying to do everything yourself. Rather than trying do things you have limited experience in, build a team of professionals who are expert in these areas. Better yet, work with us and utilize the team we have assembled for you. If you buy a deal from us you gain instant access to the entire Significa Team. Here's how we will make you money:
CREATING VALUE FOR INVESTORS
Significa has a dedicated staff of real estate advisors who create value for you in
three critical ways. For each deal, we:
· Select . . . the best investment properties by Separating the ‘Wheat from the Chaff,’ filtering through thousands of potential money-making properties and hand selecting only those that meet our exacting criteria.
· Assemble . . . a team of Real Estate professionals—contractors, property managers, title attorneys, mortgage lenders, insurance agents, etc., assuring you superior service at competitive prices.
· Guarantee . . . a smooth process that ultimately results in the kind of return on your investment that we expect.
ACHIEVE YOUR REAL ESTATE INVESTMENT GOALS with SIGNIFICA
“LET'S GET WEALTHY TOGETHER!”
About the Author: Merrill L. Beyer III is a recent licensee who just joined the Keller Williams Real Estate office in Northampton County, Pennsylvania. He is currently a principal owner/partner of Significa Corporation, a real estate investment firm focused on the residential market in Eastern Pennsylvania.
Beyer has worked as a professional pilot for 40 years. He accepted early retirement as a Boeing 747-757-767 Pilot with United Airlines in November 2009. During his career, he was based at various times at New York's Kennedy, Washington's Dulles, Chicago's O'Hare, and San Francisco's International Airports, all the while commuting from his home in the Lehigh Valley.
Before joining United, Beyer served in the U.S. Air Force in a career spanning over 21 years, and he retired as a Lt. Colonel. During several operational assignments throughout the U.S. and Asia, he accumulated over 3000 hours as a fighter pilot in the F-15 Eagle, F-4 Phanton II, and twin-engine turboprop OV-10 Bronco.
Beyer is a graduate of the Air Force Academy with both a BS and MS in Aeronautical Engineering. He is a 2007 MBA graduate of Lehigh University with a concentration in Corporate Entrepreneurship.
About the Blogger: Tai A. DeSa is Chief Executive Officer of Significa Corporation, a professional real estate investment company based in Pennsylvania (www.significacorp.com, www.significashortsales.com, and www.significadeals.com). DeSa is a graduate of The Wharton School at the University of Pennsylvania. Prior to entering the real estate business, he served as an officer in the U.S. Navy. He is the oldest in a family of 11 children and was valedictorian of his high school class. DeSa is also an Associate Broker with Keller Williams Real Estate (www.thetaidesateam.com). He is an organizer of the Lehigh Valley Real Estate Investors Group (www.lvrig.com) and an Area Director with Business Network International (www.bnidvr.com).