Erion Shehaj

The biggest challenge of 2014 for long term real estate investors

February 3, 2014 By Erion Shehaj Leave a Comment

Sometime around the summer of 2013, the investing landscape in Houston began to change at a rapid pace. Demand soared, inventories shrunk to record levels and the Houston real estate market lit up like a wildfire.

Bank owned foreclosures, the perennial sweethearts of investors everywhere that had accounted for one in four sales just a year ago, now barely contributed six or seven percent. The few properties that banks were bringing to market were either inaccessible to investors (in favor of owner-occupants) or priced at market prices despite the need for repairs.

Meanwhile, builders started ramping up construction to complete subdivisions that had been developing at a snail pace and break ground on new communities. But as one builder told me, “after five years of increasing construction costs and stagnant prices the market was finally allowing them to raise prices”. And raise prices they did. Same subdivision, same property that had been selling in the high $140s, first went to the mid $150s then mid $160s in six months’ time. Fortunately, rents kept on rising right alongside prices so it made sense up to a point. Then prices rose out of reach.

Finally, the owners of existing homes with plans to sell started setting their pricing sights ever higher boosted by anecdotal evidence of neighbors’ homes selling in a matter of days at full price and multiple bids.

As a result of this combination of higher demand and tighter supply, we ended up with record numbers in sales, prices and inventory for 2013:

So what does this mean for investors in 2014?

After that synthesis of the second half of 2013, the knee-jerk conclusion that some investors might draw is that the “train has left the station” and the prudent course of action would be to sit tight and wait for prices to come back down to the good old 2010-2012 levels. While I understand the impulse to draw that conclusion, I think it’s misguided on several levels.

First, the idea that if we just wait it out, prices will come down in short order is based on the assumption that we are currently in a bubble that will burst soon. That couldn’t be further from the truth and here’s why. From 2008 till the end of 2012, home prices in the Houston area were pretty much flat. They didn’t go down much (like California, Nevada, Florida and the like) but they didn’t go up either. That was during the 2008 recession. In 2013, prices went up 10% for a single year after five sideways years. If that constitutes a bubble, I’m Irish. In a real estate recovery, what do you suppose prices should do? Not only are prices not going to come down shortly, but they are likely to go up some more. In fact, Forbes (among others) predicts that prices in the Houston-Sugar Land-Baytown metroplex will grow about 24% over the next 3-4 years. So waiting on the sidelines will not help but rather hurt your efforts as an investor.

Second, if you are an all cash investor that does not utilize financing, the price you pay for a piece of property is the single determining factor in how that property will perform as an investment. But for the overwhelming majority of long term real estate investors, that’s not the case. They will put down a large down payment (20-25%) but will finance the rest. For that overwhelming majority, prices tell only part of the story. The terms of their financing tell the rest.

Here’s what I mean: Suppose there is a property that you can purchase for $150k today (and finance $120k of it at 5.25%) or you could wait a year and buy the same property for $127,200 (and finance 101,750 of it at 6.75%). Do you know that for cash flow purposes, the cost of both properties is exactly the same? And here’s the kicker – the scenario where interest rates rise 1.5% over the next 12 months is a lot more plausible than the possibility of prices dropping by 15% in the same timeframe!

Third, it’s very important to understand what happens to an investment’s returns in an environment of rising prices. There are two dynamics at play – On one hand, paying more for the same stream of income puts downward pressure on cashflow returns. If before you could get 12-16% cash on cash returns, now you’d be looking at 9-10%. But, on the other hand, suppose you acquire a property for $150k in January 2014 investing $35k out of pocket in the process. If by the end of the year prices rise a modest 5%, your return on investment from that appreciation for the year is over 20%! How? Well, when you purchase the property with 20% down, you invest only 20% of the amount out-of-pocket but reap 100% of the price appreciation. Therefore, that $7,500 increase in asset value (5% of 150k) represents a return of over 20% on your invested cash of $35k in addition to the cashflow return you realized. So, the same factor that compressed your cashflow returns is the same factor that caused your appreciation returns. To be fair, cashflow returns are different in the sense that they are reaped every year whereas appreciation returns require the sale of the asset to be reaped. But the goal of a long term real estate investor is maximum cashflow at retirement facilitated by capital growth until that point. In that context, this new environment of slightly lower cashflow returns and higher appreciation returns accomplishes the same goal via a different path.

The Biggest Challenge

That brings us to the crucial point of this article – the biggest challenge of 2014 for long term real estate investors. One Word: Supply. From where I stand, the ability to find and acquire assets to assemble your portfolio will continue to be the principal challenge for long term real estate investors this year. Over the last six months or so, my principal focus has been to find solutions for this challenge. And I am happy to report that I will be sharing some of those solutions with you in the coming posts. So stay tuned – it will be worth it.

Note:

After an avalanche of a fourth quarter and a major life event (we had a healthy baby boy in December), I have been absent around these parts for quite some time. I really appreciate that many readers have reached out and missed the regular writing. I can’t begin to tell you how much I miss it myself. Although mildly sleep deprived (sleep is overrated, anyway), I’m back on the saddle and I look forward to the discussions on the blog. Thanks for sticking around –

Investing Architect

Scorching Houston rental Market in August: Record rents (+6.6%) and properties leased (+14%)

September 6, 2013 By Erion Shehaj 2 Comments

I’ve been absent around these parts for a couple of months because let’s face it: Who wants to hear about real estate market statistics when the alternative is to carry your favorite ice cold adult beverage as you contemplate how it will take before the waves reach your beach chair. But now that the tan is starting to fade away, it’s time to get back to business. And what better way to dive right in than to take a look at the performance of Houston’s rental market during the month of August.

Our Houston Investment Grade Rentals (HIGR) Chart brings all good news – In the high quality locations that we track, there were 727 properties leased in August. This is the second highest number of properties leased (after July’s 729) on record and year over year it represents at 14% jump. As you will probably notice from the chart, properties leased and prices typically spike during July and August due to the wave of tenants looking to get situated before kids go back to school. But even after accounting for the seasonal spike, the considerable year over year jump points to a significantly hotter market this year.

Good news also from the price front. The lease price of properties leased during August matched July’s record average of $1638. That level represents a 6.6% increase over last August.

Days on market increased slightly to an average of 22 days (last year’s DOM were 19.74) showing further proof that the larger number of properties sold and higher lease prices did not significantly impact the time properties spent on the market.

Historically, the rental market tends to take a breather during the last quarter of the year with an overall lower number of properties leased. However, rental prices tend to stay unchanged. So does this mean that you should try to time your purchases just right and take advantage of the seasonal spike in July and August?

No.

The primary reason why there are fewer properties leased out is due to the fact that there are fewer properties available for lease during these months. Read: Less competition. And most importantly, if you follow our advice and purchase high quality properties you have a built-in competitive advantage over other plain properties.

You can’t control when the right deal will come along especially in a hot market like this just like you can’t control when a property might need to be leased out again due to a tenant moving out. So, trying to get the seasonality just right can be a costly move.

May rental market report: Available inventory and units leased jump as days on market shrink

June 4, 2013 By Erion Shehaj Leave a Comment Tags: rental market report

The rental market data for the performance of investment grade rentals during the month of May is in and it offers some fascinating insight.

First let’s start with the biggest surprise: At the end of May, the available inventory of rental properties in the quality submarkets that we track jumped to 569 (+22% over April) even as the units leased during the month of May increased 9% year over year (and 7% over last month). In my opinion this comes as a result of two factors. First, this is an indication of increased purchasing activity by real estate investors that are buying at a faster pace in an attempt to avoid interest rate increases in the horizon. Second, since we are getting into the hottest time of the year for rentals, many of the units leased last year with one year terms are coming up for renewal thus contributing to the higher inventory.

The current number of units available for lease and the average rate of properties leased over the last 12 months represent 33 days of inventory on the market. Given the feedback we are getting from the rental market on a first hand basis, I think the added inventory will lead to an even higher number of units leased during the month of June.

Finally, rents rose by 3% year over year (declined 0.8% over April’s figure) and days on market shrank to the second lowest level since 2007 (21 days). This is good news for investors who are looking for a counterbalance to rising asset prices as the housing market is in full recovery mode.

chart_2 (2) — Houston Rental Market Report for May 2013

How to find and screen tenants for your investment property

May 31, 2013 By Erion Shehaj Leave a Comment Tags: Tenant screening

When you are trying to reach your retirement goals using a long term real estate investing strategy, there is a multitude of factors can make the crucial difference between success and failure. To mention a few, the quality of the location and school district, the price to rent ratios in your portfolio and the terms of your financing are all factors that lead to underwhelming results when compromised.

But if I had to pick one factor that all successful long term real estate investors must get right, one ingredient that is necessary for your portfolio to achieve its full income potential, I’d have to go with the ability to find and keep great tenants. Without great tenants, your dream retirement unravels into a hassle laden, vicious circle of vacancies, evictions and problem calls that typically keep skeptical inventors from investing in real estate in the first place.

With that in mind, I’m convinced that one of the greatest services we provide for our clients on a daily basis is the procurement of great long term tenants. So today, I wanted to share with you some pointers on how to find and screen potential tenants to find the hidden gems that will pay rent on time for a long time and take care of your property like it’s their own.

Before I begin, I want to point out something of outmost importance. The investment properties you buy generally attract (and essentially pick) the type of tenant you will eventually have. If you buy a property in a bad location, with high crime rates and low quality schools your applicant pool will consist of tenants that would want to live in that property. There’s no magic wand that would allow you to find great tenants for a low quality property. So, what follows assumes that the property itself is an investment grade property in a good location that would attract a well qualified tenant.

Now that we got that out of the way, let’s say you just closed on a great investment property and are anxious to find a great tenant (as 100% of investors are). How do you go about finding and screening applicants in a methodical and proven way?

First let’s tackle the “finding part”. At the outset you have to let the market know that you have this great property available for occupancy. Painfully obvious, I know. But you’d be surprised how many investors fail at this stage in a futile quest to save a few hundred bucks. In order accomplish this, your property needs to be listed/advertised/posted where potential tenants look for rental properties. That means your property must be listed on:

The MLS – A large percentage of the great tenant pool are relocations into the city where your property is located. These tenants are usually well qualified, have high paying stable jobs and they HAVE to move. So all the ingredients are there in a neatly wrapped package. Now the wide majority of these clients have agents who represent them that were assigned to them by the relocation company. Their agents aren’t going to drive by neighborhoods at random and see your red “For Rent” sign you bought at Lowe’s. If your property isn’t on the MLS, you essentially don’t exist for a large section of the very tenants you are hoping to attract.
Every Real Estate Portal – Your listing needs to be on every real estate portal that accepts lease listings: Zillow, Trulia, Hotpads etc. Do all these work all the time? Not really. But you are trying to cast a wide net and see what brings in the haul. The good news is that most MLS these days automatically syndicate to these portals. Or in the event the one in your city doesn’t, there are websites you can use to upload the property once and propagate it to all portals (i.e Postlets)
Craigslist – Finally, the godsend for landlords everywhere. After the MLS, Craigslist is the second largest source of tenants we have found. Your listing must be on Craigslist and it must be there as often as they will allow you to be there.

But the fact that your property is listed in these places, is as important as how it’s listed. In order for your property to stand out, you must have well lit, high quality pictures taken. If you don’t have a high quality camera and flash, hire a professional photographer. It will be the best Benjamin you ever spent. Pictures are crucial.

Last but not least, the ad for your rental property needs to resemble the ad for a job. Just like the employer paints a picture of the ideal candidate they would like to hire, so should you describe the exact tenant you are looking for in specific detail. Don’t be afraid to alienate the candidates that don’t meet your criteria (provided your criteria are reasonable and most importantly, legal). You’re not trying to generate interest for interest’s sake. You’re trying to generate targeted prospects that have a high probability of getting approved.

That brings us to the second part of the discussion: The screening process. Suppose that your marketing efforts have paid off and now you have lease applications from prospective tenants. What are the factors that will determine the eligibility of the tenant or lack thereof? In order of importance:

Rental History
Sufficiency of Income
Employment History
Background check
Credit Check
Pets
References

The prior rental history of the applicant is a great indicator of how they are likely to perform during your lease term. So in most cases, serious problems in the applicant’s rental history lead to the rejection of the application. What you are looking for here is at least a two year history of leasing properties with no issues. Any prior evictions, collections from previous landlords, lease breaches etc tend to indicate problems that are likely to repeat themselves so we avoid them every time. Other aspects of the applicants’ rental history that matter are the typical length of their prior leases and the rent amount they’re “used to paying”. If the history reveals a tenant that moves every 3-6 months, that might not be the best fit if you’re looking for a long term tenant. And finally, you want to avoid the effects of rent increase shock. A tenant that has been paying about the same amount of rent over a period of time is less likely to be shocked than a tenant that’s used to paying half the rent you’re asking.

Sufficiency of income is paramount to avoid future defaults, evictions and vacancies. In fact, one of the principal reasons that lead to evictions is the investors’ own carelessness in placing a tenant in a property they can’t afford. This may sound like overkill but what you need to do to determine sufficiency of income is to run a down and dirty budget for your tenant. How much of their gross pay do they take home? How much “disposable income” is left over after they pay your rent, utilities, food, gas, and monthly payments? If the answer is “not much” you’re one car problem away from not getting your rent paid. Why would you do that to yourself on purpose? So, to insure there’s enough income there to support the lease, we require tenants to make 3.5 times the monthly rent in gross income. Essentially, we want the lease payment to be no more than 28.5% of their gross pay. Last but not least, their income has to be reliable (salaried or base, not variable commissions) and documentable through pay stubs or tax documents.

Employment history addresses the probability that the income we’re relying on is likely to continue during the lease term. Typically, we look for at least 2 years in the same line of work (they can be at different companies as long as its the same job and level of income). Of course there are exceptions – for instance a recently graduated college student with a solid job offer letter for a reputable company.

The background check is another go/no go criterion. It must be clean of any issues that show character flaws (theft, violence, fraud, drug related issues and other serious criminal offenses). We look at small misdemeanors on a case by case basis. If its an issue that happened 20 years ago and the tenant has no issues since, that’s looked at differently than something that happened last week.

The credit check is a tricky one because investors tend to simplify the matter down to a credit score. I don’t agree with that approach. More important than the score is the story. Some credit reports tell the story of an applicant that’s always late on all payments. Others, tell you about a rough patch the tenant may have been through a while back due to a job loss or medical issues but also speak of solid payment history since then. The funny thing is, both candidates may have the same exact credit score. And I’d lease to the second (provided all the aforementioned criteria is in order) but not the first.

Pets are another issue that requires a lot of care. If you just purchased a quality property in a great location you might be tempted to categorically disallow pets to prevent damage to your property. The problem is, a large percentage of the “great tenant” pool have pets so by excluding them you’d be missing out on some great candidates. Besides, pets require a lot of care and dedication so in a way, the fact that your tenant may have a pet is a sign of maturity and stability. But on the other hand, some pets can cause a lot of damage to properties. So, it’s important to get this right. Usually, we go with a case by case approach on this. We place weight limits (40lbs) and total number of pets limits (2) as well as exclude breeds considered dangerous to eliminate liability. We also charge non refundable pet deposits for each pet to mitigate the risk.

Finally, you want to make sure that the information on the lease application is true and correct and has not been “enhanced” by the tenant to fit what you’re looking for. You do this by checking references. Check county records to make sure the listed landlord truly owns the property they leased and isn’t a friendly uncle. Then, call all previous landlords listed and ask open questions (not yes/no questions). After you’ve verified the information as correct ask them if they’d lease to the tenant again if given the chance. Repeat the process with their managers at work.

There’s no possible way to avoid all defaults and problems as they’re part of life (even qualified tenants can be laid off) but if you follow the advice I’ve just given you to find and screen great tenants for your investment property, you’ll reduce their occurrence to a minimum.

Juhan Sonin via Compfight

Houston housing market continues upward surge: Double digit gains in sales and prices

May 29, 2013 By Erion Shehaj 5 Comments Tags: Housing market

If you were expecting the Houston housing market to take a breather in April after the strong performance in the first quarter, you’d be very disappointed with the numbers reported by the Houston Association of Realtors. Instead of a pause, the market continued its uncompromising upward surge by posting double digit year on year gains in sales and prices. Below are the fundamental stats worth knowing:

Single Family homes sold: 6482 (+ 27% from last April)
Single Family average price: $253.9k (+14% year on year)
Single Family pending sales: 4999 (+23% year on year)
Months of Inventory on the market: 3.4 (-37% from last April)
Bank foreclosures down 30%, now make up just 10% of total sales
Townhouse and condominium sales + 31%

The storyline remains unchanged. In 2013, demand awoke from its confidence deficiency paralysis and realized that time was expiring fast on ridiculously cheap money. This awakening led to an acute inventory (supply) shortage which turned this market into a dog chasing its tail at a blistering pace and driving up prices in the process. The latest reported average sales price during April is the highest on record. To find a higher number of properties sold in a month, you’d have to go back to August 2007 and its pre-recession self. Just when you think suppliers of supply (builders, sellers and banks) might jump in, satisfy the demand and increase inventory, months of inventory on the market drop further to 3.4 months. And that’s citywide. If you zoom into smaller, popular pockets (i.e Woodlands, Memorial, Oak Forest/Garden Oaks), there’s even less inventory

Funny thing is, the Summer is just getting started.

Houston Association of Realtors press release

Jonathan Phillips via Compfight

April rental market report: Highest rents on record plus units leased soar 24%

May 2, 2013 By Erion Shehaj Leave a Comment Tags: rental market report

Every year since 2007, the number of properties leased during the month of April had been 8-10% lower than the corresponding March figure.

This year, the Houston rental market shattered this well-established trend. According to statistics obtained directly from the MLS for investment grade rental properties, a total of 507 single family homes were leased during the month of April. That figure represents a 24% increase year over year and an 8% jump over last month.

The solid jump in units leased was certainly welcome news. But was this increase as a result of higher demand or lower prices? The numbers answered that question emphatically in April. Average rents climbed to $1578 per month – a 6% increase year of year and a 3% jump over March 2013. Not only that, but the April average rent is the highest rent on record. So clearly, organic tenant demand is the culprit not reduced rents.

Average days on market came in at a low 27 days – on par with both April 2012 and last month.

Available inventory of investment grade properties for lease dropped to 465 homes (down from 507 on April 1) on the back of the increase in units leased. When we look at the average units leased over the last 12 months, that number comes in right at 500 properties/month so there’s less than 30 days inventory on the market. The current supply demand relationship points to further strength in the rental market for investment grade properties in the months to come.

houston rental market — Houston Rental Market Report for April 2013

To view our interactive Houston Investment Grade Rentals (HIGR) Chart click on the chart image above.