Investing Architect

Author: Erion Shehaj

Flipping vs. Long Term Investing – Why it’s not even a close contest

When a new real estate investor sits down and looks at one of our cashflow analysis for the first time, she usually has a puzzled look on her face. And it’s understandable – Here she is looking at a financial projection where she invests $30,000 of her hard earned capital for an annual return of $3600-$4500 per year. Sure, 12-15% cash on cash return is nothing to sneeze at but in the end $4k per year won’t exactly change your life. It isn’t the lucrative, rich overnight image projected when people speak of real estate investing. It’s not the sexy buy-renovate-resell-double your money kind of strategy. So inevitably, the question comes up: Wouldn’t it make more sense to purchase a home to flip with that capital and earn much more money in a very short term? This is the part where I smile.

The debate over the merits of flipping homes versus investing in real estate long term is not even a close contest. As a matter of fact, they don’t even belong on the same debate stage and in this post I intend to show you why.

Our starting point is a look at the real math of flipping homes. Let’s look at the facts: even if you were able to acquire the property low enough, by the time you pay selling costs, closing costs, holding costs, rehab costs and Uncle Sam, your true return on investment isn’t exactly what you expected even in the most optimistic of scenarios. But let’s assume you are reasonably successful and don’t make any major mistakes. In normal times, reasonably successful flips take 100-150 days to complete – purchase to resale. So, assuming that you’re not running multiple crews (which most new investors don’t) you could complete two to three flips a year and make $35k-45k per year after tax. That’s if none of those flips end up being break even deals or worse, money losers. In a perfect world with no market downturns that wipe out more flippers than a Japanese tsunami, you could make $350k to $450k in a ten year period. No income. If you want to take a break from flipping homes, the money flow grinds to a halt.

Now let’s look at a similar situation where the investor executes a long term investment strategy instead. The investor methodically acquires nine investment properties in great locations with high tenant demand over 36-48 months. On our advice, she opts to go for capital growth first and income later. So, she grows her capital by aggressively paying down the mortgages on her properties according to our Domino Strategy using positive cashflow from the properties themselves and her job income. All in all, she invests $300-340k of her capital and ends up with a free and clear portfolio in 10-12 years. This portfolio is worth $1.2M without a penny in appreciation over that time frame. In addition, her portfolio provides our investor with over $100k in annual income thereafter. So let’s do some arithmetic: From $300k to $1.2M in 10 years is $900,000 of capital growth or $90,000 per year. And on top of that there’s $100k of annual income to boot? And you didn’t have to deal with contractors for 10 years of your life, nonstop? And you can take off to your favorite island for a month or two while income still flows to your account regularly? As I said, not even close.

Mitchell Joyce via Compfight

October 3, 2012
Big news for real estate investors: Fannie loosens lending guidelines

It seems just before the ink dried on my last post about financing for investment properties, an update is required. And this is a very welcome update I’d like to write more often.

As I pointed out previously, long term real estate investors were restricted to a maximum number of 10 conventional mortgages they could have outstanding at one time. So if your investment goals required more properties, you were either up a creek or had to look at alternative less favorable types of financing i.e portfolio loans or lines of credit.

Well, as of today, Fannie Mae has expanded that number up to 20 mortgages provided that the investment property being financed is part of their own portfolio of foreclosures AND you use Homepath financing (from an approved Lender that offers it).. Starting with the 11th mortgage, real estate investors will be required to put down 30% of the purchase price, up from 25%. That should be a non issue since real estate investors have long been willing to commit more capital if they were allowed to finance more properties as the BiggerPockets/Memphis Invest survey showed last week. No indication yet of the interest rate premiums that will be charged on these loans although I would think there will certainly be some premium.

There are certainly some strong limitations to this policy change. Investors who purchase new construction or non Fannie foreclosures would not be able to utilize it and would still be restricted to 10 mortgages. This comes across as a move to clear Fannie Mae’s pipeline of foreclosures faster. It’s amazing that it took them so long to figure out that well capitalized investors are a common sense solution to clear up the glut of foreclosures. But I digress.

The demand for Homepath approved foreclosures is almost guaranteed to spike in response to this change in policy. If you need a list of approved properties in the Houston area or a lender recommendation, call my cell at 713-922-2702 or contact us up top.

Is this change perfect? Not really. But in real estate investor land, today was a good day.

September 25, 2012
Financing for investment properties – A Primer

Fair warning – this will be a long one because it needs to be. Financing is a crucial component to investing in real estate long term because it impacts both your returns on investment and your investing experience. If you opt for the wrong kind of financing, that could mean that a great investment property isn’t cashflowing like it should due to your interest rate being too high. Or if you go with an inexperienced Lender, the process to obtain financing will be so tedious you won’t want to do it again. So, this post will go over the different financing options for investment properties in succession – meaning, we will start with the most optimal option for long term investing and then cover alternative options once the former is no longer available.

Conventional or conforming financing

As long as it’s available, conventional financing is the recommended route for long term real estate investing. Conventional loans have to abide by Fannie Mae/Freddie Mac guidelines. At the time of this writing, the guidelines allow for any qualified borrower to carry up to 10 conventional mortgages at a time, including the mortgage on their primary residence. So if there’s still a mortgage on your home, you can purchase a maximum of 9 investment properties with this type of financing. This of course has been and will continue to be subject to change just like anything else that’s dependent on a government entity. At times investors have been able to purchase an unlimited number of investment properties, as long as they had the income to support them. At other times, the number has been arbitrarily shrunk to as low as 4 mortgages. Up to the first four properties, conventional investment property financing allows a minimum down payment of 20%. On the next 6, the down payment requirement escalates to 25% and the cash reserve requirement increases as well. Loan terms can be as high as 30 years or as low as 10 years. As a rough rule of thumb, interest rates for investment properties are generally 1 percent higher than your primary home loan rates. They fluctuate from day to day but at the time of this writing they have been in the 4.25-5.25% range.

The biggest advantage to this type of financing is that it offers the lowest fixed interest rate and closing costs of any other option. It does require excellent credit (generally scores above 700) and substantial down payment. But over the long term, properties acquired with this type of financing will cashflow better due to the low interest rates and lower loan amount as a result of the higher down payment.

When shopping for a Lender to provide this type of financing it is recommended that you work with a company that specializes in financing investment properties. Most Lenders you speak to will tell you that they do provide this type of financing but most of them are just home loan lenders. Here’s a question you should ask them to help you determine if you are working with a pro or not:

“I’m planning on purchasing multiple investment properties this year. When you finance my third or fourth home for the year, what percentage of the rental income from my other properties do you count?”

If you’re dealing with a run of the mill home loan lender, they won’t be able to count any of your rental income until it shows up on your tax return the following year. This would be a major obstacle as it would constrain you to purchasing one property per year. But even if you aren’t planning on purchasing multiple properties that year, this is a great litmus test to filter lenders. Because, if they aren’t setup to handle investment properties, their guidelines will be much stricter as well which will increase your hassle factor.

In addition, you want to use a Lender that has in-house underwriting – not one that’s just a middle man, brokering your loan to some other Lender halfway across the country. Lenders that handle the entire process in house generally offer a smoother process. As they say in Texas, a good lawyer knows the law, a great lawyer knows the Judge. Lenders with in house underwriting know the decision makers, what they look for in a file and how they want things presented. That means your loan gets approved faster and with less hassle.

Last but not least, what truly separates the cream of the crop Lenders is the ability to service their own loans if need be. See most Lenders use an “originate then sell” business model – meaning, they make a loan that conforms to certain guidelines then sell it to big banks buying loans on the secondary market. However, some Lenders have the capacity and the muscle to service some of their own loans – in other words, take payments from their customers for some time. That’s a huge advantage to the investor because if for some reason their loan doesn’t fall within the “box” of conventional guidelines, these Lenders can still approve the loan and keep the loan in their portfolio.

Portfolio Loans

Let’s say you are maxed out on the number of conventional loans available to you for investment property purchases but you need to acquire more assets to reach your retirement goals. What are your financing options?

Enter portfolio loans – these are commercial loans offered by small to midsize local or regional banks. The terms can vary substantially from bank to bank but the best banks offer 15 year loans, 20% down with 6.5% interest fixed for 5 years, then adjusting to Wall Street Journal Prime plus 1% (but no lower than 5.5%). That’s a mouthful, I know but it’s pretty simple. First five years, it acts just like a fixed rate – afterwards, it adjusts based on where interest rates are at the time. There is no arbitrary limit to the number of properties you can buy as long as your financials support them. Loan fees are comparable to conventional mortgages – and in some cases they are even lower. The process to get approval takes a little longer than a conventional mortgage so you should allow 45-60 days for closing on your investment property to be on the safe side. The rate isn’t fixed for the entire term of the loan but you can drastically reduce the risk that rate adjustment poses by paying off your portfolio loans ahead of your conventional loans as part of your domino strategy. So in five years time, that mortgage won’t have a chance to adjust as it will no longer exist. And after the last properties purchased with conventional loans at 25% down, the 20% down requirement should provide some relief to your capital investment and allow you to acquire more properties in the long run.

Lines of Credit

At times, when a real estate investor has solid long term relationship with a local bank, they will grant him a line of credit to be used for purchasing investment properties. I know what you’re thinking: People still have strong relationship with banks?! But local institutions that do banking the old fashioned way, that grow as their customers grow are rare, but they’re still out there. Typically these lines of credit carry variable interest rates so the investor assumes all risk of a spike in rates. Also, the bank usually reserves the right to review and pull their lines of credit as they see fit. When that happens, the investor has to pay back everything owed on the line of credit on the spot. So definitely not an option for those of us that don’t take kindly to risk.

The positive of using a line of credit is that it gives the investor a lot of control over how to use the money. The negative of using a line of credit is that it gives the investor a lot of control over how to use the money. 🙂 When there’s OPM (other’s people money) at your disposal, many strategies that would feel too risky to invest your own money on start to seem attractive. All of a sudden you might get an urge to flip a thousand homes a year like that fine fellow on the TV infomercial. Remember you still have to pay it back – it’s far from FREE money.

Last words

If you are thinking about investing in real estate long term, your success depends on securing high quality financing with low interest rates and good terms from a seasoned pro. Anything less and it will show in your results – that is if there are any results left. For your sake, get this right from the beginning. We help our clients source financing for their properties every day and we can do the same for you. If you need a recommendation or have a specific question, call my cell at 713-922-2702.

Philip Taylor via Compfight

September 20, 2012
How to have your cake and eat it too with real estate investing

Picture going into your investment advisor’s office to talk about your impending retirement, 15 years from now. You proceed to tell her that what you’d really like to accomplish is to quadruple your investment AND draw a six figure income at retirement. Now picture her chuckling and you being dressed down to more realistic expectations. When you think about it, most other investment vehicles consider the growth of your capital and the income derived from it to be mutually exclusive. If you want income, you have to purchase dividend yielding stocks or mutual funds which tend to experience minimal growth. Or if you are trying to grow your capital, the securities that provide it don’t yield any income. That’s life after all: You can’t have the cake and eat it too. Right?

Except, there is an asset class that can provide strong capital growth and enough tax sheltered income at retirement. So the purpose of this post is to show you exactly how to have the cake and eat it too with real estate investing. Hint: It’s all about timing.

In a previous post, I have discussed how to create a six figure income with real estate investing. It’s one of our most popular reads on the blog, so if you have not yet read it, I strongly recommend it. But in a nutshell, it shows you how the acquisition of 9 well located, quality single family homes combined with a disciplined domino strategy leads to a free and clear real estate portfolio worth about $1.2M in a 12 year timeframe. At your retirement point, this portfolio would yield about $100k in annual income. The cash investment required to acquire such a portfolio would be in the $270-$300k territory.

So we invest $300k and turn it into $1.2M – that’s increasing your capital to four times the size it was when you started. And in twelve years time, that yield $100k in annual retirement income. How’s that for having the cake and eating it too?

So where’s the magic? As i hinted before, it’s all about the timing. Most long term real estate investors want to build cash flow but they need it at retirement, not right now. That is to say, they don’t need the cash flow from their properties to pay current monthly bills or subsidize their current income. Therefore, we recommend that between the starting point and their retirement point, the investor stay focused on capital growth. In other words, use cash flow produced from tenant paid rents to grow your capital by aggressively paying down mortgages till they’re free and clear. And when they’re free and clear, they will produce more income since no portion of incoming rents have to go to banks as mortgage payments. That results in the investor being able to draw a great income from their properties while still holding on to free and clear assets (their grown capital).

It’s a truly beautiful thing. And don’t let the capital invested in the example scare you – this strategy works well with fewer properties, too. Besides, when you consider that just between the ages of 30 and 45 people can (and do) invest over $200k in their 401(k) only to see it decimated by market downturns, it doesn’t seem such an outlandish figure after all. But in the end, you need two vital ingredients to make this a reality for you: A Blueprint and laser focused discipline.

I can help you with both. Give me a call on my cell at 713-922-2702 and let’s talk about your goals and how to achieve them.

photo credit ulteriorepicure

September 14, 2012
Real Estate Investors: Know thyself before you wreck yourself

Real estate investors come in different varieties. Some are so risk averse that they keep six months of payments in cash reserves for each investment property they own. Others don’t really feel like they’re investing unless they’re going “all in” on some deal every week. But no matter where you fit into the risk spectrum, you should know exactly where you stand before you start investing. Then pick investment vehicles, strategies and advisors that suit that investment “personality”. I know that on the surface it sounds like a cliche piece of advice you might expect to find in a Yahoo Finance article. But in fact, it is crucial to your real estate success. Two cartoonish case studies for you:

Nathan Vegas wants to get started in real estate investing. He loves risk and adores leverage. He wants to invest in real estate for cash flow so he can quit his job and do what he loves. He wants to reach the desired level of cash flow by next Thursday by 6pm. So the strategy is to purchase investment properties that sport a freakishly high cap rate so he can get the highest return on his current capital. And there’s not much time left so he won’t have time to do any proper due diligence but that’s a risk he’s willing to take. After all, how wrong could these proforma statements be?

Meanwhile…

Brenda Conservative has been mulling over investing in real estate for seven years now and is just halfway through her due diligence. Her favorite topic when scrutinizing investment properties is: 7 ways buying this house could lead to bankruptcy. Just as she’s getting close to pulling the trigger on an acquisition, a new report about how Europe is imploding stops her in her tracks. She wants to retire in 20 years but wants to make sure she doesn’t make any fatal mistakes. Even after making the first purchase, she hesitates to act on other good opportunities because she feels like she’s moving way too fast.

I’m obviously exaggerating profusely and humorously. But I do it to illustrate this point: Who you are and how you think about real estate investments matters in the highest degree. Real estate is a long term investment vehicle and in many ways it’s like a pot roast. It requires time to yield delicious results. Without it, you’re left with a piece of tough, chewy meat. Nathan in the example above, wants to create cash flow before building a sufficient capital base so he tries to shortcircuit the system by buying high “yield” assets. We all know what happens when you shortcircuit… What he is sacrificing to obtain speed is the quality of his portfolio. And when you sacrifice quality you tend to find out very quickly that there’s significant difference between “actual” and “pro forma” and only one of them matters to your banker. Nathan is trying to fit a square peg in a round hole – that is use a long term investment strategy to accomplish a short term goal that requires a huge risk undertaking. He would be better served by using shorter term riskier strategies like flipping or wholesaling strategies. He might even venture outside of real estate and open a business or invest in small cap stocks – both high risk high reward propositions.

Conversely, Brenda wants to reach her retirement goals and she has time on her side but her risk aversion can stand in her way. Because without acquiring the necessary assets to build up her capital base, she will never achieve the level of income it will take for her to retire, regardless of time. But her aversion for risk can’t be discounted away either because it outlines her comfort zone and that’s who she is at her very core. Instead, the real estate investment strategy that better suits her style is one that involves quality assets in great locations even if rates of return are more tame.

Last but not least, who you are should align with where your investment advice is coming from. Brenda shouldn’t work with an investment advisor that urges her to try flipping homes and Nathan shouldn’t work with someone like myself. 🙂

Zuhair A. Al-Traifi via Compfight

September 10, 2012
The cure for underperforming real estate investments

Sometimes people become real estate investors on purpose: They have a clear goal, they plan for it, analyze investment opportunities then pull the trigger on the option that better helps then achieve that goal. However, at times one can become a real estate investor by inertia. The property could be a former residence that got converted to a rental once they moved up in house. Or it could have been student housing for their children while they were going to college and became a rental once they graduated.

In the end, it doesn’t really matter that much how one comes to own an investment property – it matters how that property is performing and whether it is propelling that investor towards the fulfillment of that goal. So in that spirit I want to ask those inertia investors a Dr Phil question: How’s that been working out for you?

Certainly, there are exceptions as there are with every rule. But in the overwhelming majority of cases, the property is underperforming as a real estate investment. It might be breaking even or even costing the investor some money every year. But it’s easier to continue that inertia “trend” then to do something about it and right the ship. It feels that way because the opportunity cost of sticking with an underperforming property isn’t readily apparent. So allow me an illustration.

Jim Investor owns a property worth $130k with a $85k remaining balance on the 5% 30 year mortgage with 16 years left on it. Currently the property pays for itself most years except when repairs exceed the “normal” range. So Jim sees no reason to fix a situation that’s “not broken”. Let’s take a quick look at the numbers. Jim has $45k in equity in the property. Best case scenario, his return on that equity is the amount that goes to principal from his mortgage payment or $1959.54. That’s a 4.3% return on a best case scenario! What happens when the AC has an issue and needs a major component replaced? Rhetorical question.

If you’re in the same situation, here’s how to tell whether you should stick with the status quo or make a move to improve it. Answer this question: If you didn’t own that property, would you go buy it today as a pure investment property? If the answer is no, there are much better opportunities for that equity capital within that property. You could sell the underperforming asset and trade to purchase a newer property in a better location with higher rent demand than the current. And your rate of return would be 4 times the best case scenario mentioned above. Isn’t it time to take control and be intentional about your investing?

If you’re in this situation currently and would like to do something about it, call my cell at 713-922-2702. I will show you step by step how we can go from “inertia” to “on purpose”.

Aftab Uzzaman via Compfight

September 4, 2012