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The answer to THE most frequently asked question by real estate investors

January 3, 2012 By Erion Shehaj 1 Comment

Today I want to start by making a statement that’s as powerful as it is obvious. The critical foundation for any long term investment strategy is incoming rent. Without it, all projections fall apart, all returns vanish. Earth shattering, I know. But obvious as it is, is it any surprise that THE most frequently asked question I get from all real estate investors without exception is: How do I know that the property will rent quickly and stay rented? This question deserves an answer that’s better than just encouragement: It deserves solid facts.

The experiment

So facts I went chasing to provide an answer that will show how the Houston rental market actually performed in 2011. I analyzed all rented properties that closed in 2011 that fit the property profile we recommend: Built after 2003, Minimum 3 bedroom 2 bath 2 car garage and at least 1600 SF zoned to the best school districts in the city for the money. The results themselves didn’t stun me as I see them in action in my business every day. Their consistency across the board however, really did. Take a look for yourself:

As you can see, the average time it took for properties in that category to get a tenant was between 33-48 days. When you consider that after closing on an investment property the first mortgage payment isn’t for at least another 30 days that ought to put a smile on your face. And when you add to it that the average days on market for the properties we listed for lease in 2001 was 24 days, that’s even more cause for comfort.

But days on market are just part of the puzzle. What if you’re getting your properties rented out quickly but you’re having to sacrifice large discounts off your asking price? That wouldn’t be good. Well, the data shows that the average sold to list price in all the school districts we analyzed was 99%! To put that in perspective, if you had an investment property and were asking $1200/mo in rent, the average discount in 2011 was $12. In our business we price the properties right from the beginning and always get our asking price or higher.

The Answer to the most FAQ

So how do you know if the investment property you acquire will get and stay rented? First and foremost you must not forget that it’s the right property that attracts the right tenants quickly. If your property selection is poor, getting the property rented and especially, keeping it rented will be more challenging. That’s why we remind our clients that numbers often lie and high returns can cloud your better judgment. Although chasing cheap properties in inferior neighborhoods with seemingly great rates of return may seem like a good way to score a great deal, those returns vanish if your turnover rates and maintenance costs are high. So, select the right property in the right neighborhood and finding and keeping tenants will be the least of your concerns. But you don’t have to believe me. The market told you so.

Do you have a real estate investing Blueprint yet?

Investing in new construction homes: Pros and Cons

November 14, 2011 By Erion Shehaj 3 Comments Tags: new construction

Clients often ask me what my thoughts are about investing in new construction homes purchased from the builder or developer. As with most other nuances of real estate investing, this strategy has its pros and cons. A prudent real estate investor needs to clearly understand what they are and how they can potentially impact their success. Then and only then, that investor can determine if this strategy is a good fit with their long term goals.

Pros of investing in new construction homes

Investing in new homes reduces maintenance over time

Inexperienced investors without proper guidance often disregard this principle at their own peril. If you think that the built in equity more than makes up for the fact that the home was built when Mick Jagger was a chap, I have a bridge to sell you in Alaska. The fact is, if you invest in a new home today, ten years later, that home is just ten years old. Obvious, I know. But it’s critical in the context of long term investing. As you are executing your long term Blueprint, it’s important that maintenance issues don’t undo the good progress you make increasing your capital base.

Builders incentives can be used to lower the capital invested

In an attempt to drive sales, Builders sometimes offer flexible incentives that can allow a real estate investor to limit his cash out of pocket investment to just the down payment. For instance, the asking price on a new construction property I showed last week was $133k but the Builder was offering $16k in incentives to be used however the investor sees fit. My advice to the client was to use about a fourth of that amount to cover closing costs and apply the rest toward the purchase price. That way he cuts his out of pocket investment by 30%. That doesn’t sound like much but it would allow the investor to purchase an additional home for every four homes acquired and that’s worth hundreds of thousands in the long run.

Ample supply avoids bidding wars and frustration

Unlike foreclosures or short sale listings, well priced inventory homes are plentiful so the investor can focus on which asset offers the best package of location, price, amenities and incentives, instead of getting into an ego war with twelve other bidders. The ability to acquire assets on demand can make a world of difference if say, you miss buying that house because you were chasing that great foreclosure deal that never materialized. Or if you missed out on that low interest rate for the same reason.

Buying new offers convenience and faster turnaround

When you close on a new home, you can swap the builders sign for a “For Lease” sign that same day. If instead you opt for a distressed type asset, chances are some repairs will need to be completed prior to the home being rent ready. No matter how cosmetic they might be, they do take time and they take time away from the property being available for showing to tenants. The overall process is more seamless and the experience is drastically better especially for a first time real estate investor.

Higher quality new construction attracts higher quality tenants

In our experience, high quality new construction homes with upgrades such as granite, stainless appliances and energy star ratings tend to attract higher quality tenants that won’t mind paying premium rent. So instead of renting an average property for average rent you offer a premium property for premium rent. Plus, this type of tenant tends to have higher credit scores, stable employments and won’t mind signing longer term leases. Plus, offering a property that is under builder warranty on most items for 1-2 years is a big plus to them as well. And last but not least, 10 years from now, that higher quality will translate to higher appreciation and ultimately higher returns.

Cons of investing in new construction homes

Paying retail prices

Even after taking into consideration the “rich” incentives builders offer, the price you ultimately pay for the property is the retail market value of the home or pretty damn close to it. Some investors are bothered by that fact even though to a long term real estate investor equity doesn’t matter because it’s just an indication of what would happen if you sold the property right now. Essentially you are trading off money for time: you are paying a little more for the home but you are gaining a seamless, hassle free process. Also, paying retail prices makes the investor more susceptible to strong emotions during market cycles. Here’s what I mean: Many out of state investors (primarily from California) purchased new homes from builders at the top of the market in 2003-2005 for $120-$130k. Five years later, bank owned properties next to them were selling for 20-30k less. Things have stabilized in those neighborhoods now but it was hard to see that coming in 08 when it was all doom and gloom. So, the investor has to truly be committed to the investment long term to ride out market value swings. Remember, the only market value that matters, is the one when you sell. The rest is just fiction.

The Unknowns

When you purchase a home that was built 4-5 years ago, you know exactly what the property taxes will be in the coming year and you can run your cashflow analysis with certainty. In new construction homes, the first year you own the property taxes are very low since the property is being taxes just on the land. The following year you don’t know for certain what the county will appraise the property for tax purposes so you have to estimate it. However, there are certain steps we can take to limit this uncertainty. Worst case scenario, the taxes will be the price paid for the property times the tax rate which is known at the time of purchase. Typically though, the country appraisal for tax purposes is lower than the price paid for the property. So we can run several scenarios and see if the deal makes sense. Lastly, we can see examples of properties sold by the Builder in the past couple of years and check the tax valuations of those homes for a clearer idea.

There you have it folks. Investing in new construction homes certainly has its positives and negatives. But for the real estate investor that understands them, that has a well laid out long term Blueprint and has the discipline to execute the plan it can be a very successful strategy.

7 Powerful Tips on investment property management

November 1, 2011 By Erion Shehaj 7 Comments Tags: Property management tips

The number one reason investors shun long term investing strategies is the perceived hassle of “landlording”. The concern is that this type of investment brings with it tenant calls at three o’clock in the morning, relentless maintenance, collecting trouble and the like. Since real estate investing success has as much to do with its return on investment as the overall investor experience, this is a valid concern that shouldn’t go unaddressed. So, I put together a list of 7 powerful tips to minimize the need for property management, eliminate hassle and increase your bottom line by saving on property management fees.

Property Management Tip 1: Buy New or Newer Properties

Most property management nightmares begin at the purchase. Seduced by “bargains” and equity, investors purchase three decade old properties with significant deferred maintenance and years of neglect. These “steals” often come with galvanized plumbing, electrical issues and air conditioning systems that have seen better days. Needless to say, these investors are setting themselves up for a bad experience that will often override any benefits brought by cash flow or captured equity. Instead, we advise our clients to purchase new or newer properties instead: Currently we don’t advise purchasing any properties built before 2005 (with some very rare exceptions). The reason behind this is that in a recently built home all major systems are also recent therefore less prone to breaking. Buy new (or newer) and avoid most issues that come with older properties.

Property Management Tip 2: Screen your Tenant well

This has to be both the simplest and most important property management tip in this list. Often in a rush to get the property occupied as soon as possible, investors will skip through the tenant screening process. Big mistake! The screening process uncovers whether or not the tenant has the financial ability or employment stability to afford the home or whether he/she has been a responsible tenant in the past. Inexperienced investors often view the tenants ability to afford the rent as the tenants problem, until it becomes their problem. In our practice we thoroughly screen tenants often rejecting several applications before accepting one that works. And that ends up being a win win for everyone: Our clients get a tenant that pays on time and takes good care of the property and the tenants get into a property they love and can comfortably afford.

Property Management Tip 3: Require Bank Deposits for rent payments

The advancement of banking technology in recent years can help real estate investors collect rent effortlessly and keep their tenants accountable faster. It used to be that tenants would mail a check which the landlord would receive and have to make another trip to the bank to deposit it. If a week passed and the rent check wasn’t there, the landlord would call and be told the check was in the mail. Ten days later, still no check and the tenants were then facing a situation where they would have to pay two months rent in quick succession so they’d skip out and rent a different property somewhere else. No more. Now we advise our clients to require that the tenant make a bank deposit or transfer straight into the landlords account. The tenant gets a deposit slip which serves double duty as a receipt and the landlord can log on to their Online Banking to make sure the deposit was made. If rents not there, it wasn’t put there and the landlord can hold the tenant accountable faster and collecting faster. Then, if the investor has their mortgage payment automatically deducted from that same account, they have a seamless system in their hands.

Property Management Tip 4: Buy and keep a home warranty policy at all times

Home warranty policies are an investor’s best friend. They work like an insurance policy: The client pays an annual premium (typically $300-400) and the home warranty company covers all major systems like the HVAC, plumbing, electrical, appliances etc. For every service call, there’s a $50-65 service charge and the rest is covered. So say the A/C stopped cooling: The tenant would call the 1-800 number for the home warranty company, they would send in a service technician next business day, the repair would be completed and all that would be owed is the minimal service charge. Having a home warranty only works seamlessly if you follow Tip #1 and buy a new or newer property. If instead your AC system was installed when Reagan was president, the home warranty company can decline coverage based on pre-existing condition. But this strategy has worked amazingly well for our clients. But what it the tenant has a knack for arranging service calls for every little thing? That issue is solved by our next tip.

Property Management Tip 5: Include a reasonable repair deductible in the lease

You want to make sure that the tenant has a vested interest in maintaining the property well. One way to do this is to always collect an appropriate security deposit. Another is the include a repair deductible clause in the lease. Typically our clients request the first $100 of repairs to be covered by the tenant (except on those repairs mandated by law to be covered by the Landlord in entirety). This ensures that the tenant doesn’t call you for very minor repairs every other day and it aligns the Landlord’s and Tenant’s interest in proper property preservation. Also, this clause when combined with Tip# 4 above, allows for repairs to be fully completed without the investor having to hear about it or pay for it as the deductible would cover the service charge for the home warranty.

Property Management Tip 6: Setup a separate phone number for repair calls

In an attempt to be helpful and accessible, investors often provide their home or mobile phone information for repair requests to their tenants. This inevitably leads to those infamous phone calls at 2am. There’s a better way. It starts with educating the Tenant on how the process should go once there’s a repair request. The investor needs to clearly communicate that the fastest way to take care of the issue is to call the home warranty company directly and setup a service call. For other concerns, the investor should setup a dedicated, separate phone number. This doesn’t need to be a physical line – instead it can be a virtual phone number through Google Voice. This service allows you to get a free local phone number with voicemail. If the the tenant calls and leaves a voice message, that message is automatically transcribed and emailed to the investor. If the issue is truly an emergency, the investor can take immediate action. If not, they can choose to address it the following day on their terms. Having a dedicated, virtual phone number puts the investor in control and minimizes hassle.

Property Management Tip 7: Use a-la carte vendors as needed

Sometimes, even after taking all the necessary precautions and doing everything right, investors often find themselves in a position where they have to deliver a notice to vacate or proceed with eviction. The process can be arduous and frustrating but the good news is the investor doesn’t need to be involved in it. In every market, there are companies that offer these services on a need to do basis. Need to deliver a notice to vacate? You can pay $59 and have it delivered for you. Need to follow through with eviction? $500 will get it done. The crucial point is that you are only paying for these services if and when you need them. Instead, if you hire a professional management company, you will pay a portion of your gross rent every month whether anything needs to be done that month or not.

Hope you found these tips as powerful as I’ve seen them to be in my practice. But in the end, self management, just like professional management isn’t for every one. That decision depends on many factors: location of investor, number of investment properties, and investor inclination.

If there any any property management concerns you would like me to address, please comment below and I will be happy to help.

Weaving real estate investing magic: Crafting a Blueprint

October 31, 2011 By Erion Shehaj 8 Comments

Last week, I wrote a “meat and potatoes” post where three Houston investment properties in premium locations were dissected and analyzed thoroughly. (Read that post if you haven’t already. I’ll wait). Their locations were stellar: excellent schools, amenities and access. The numbers were solid: Positive cashflow, cash on cash returns between 8-10% and cap rates north of 7%. But anyone who reads this blog knows where I ultimately stand on this. It’s not about the properties. Real estate investing is all about the strategy. Here’s what I mean.

Real Estate Investing Before Blueprint

Let’s assume you purchased those three properties I analyzed in that post. To make the calculations simpler, we will assume they’re purchased at the same time. Let’s look at what was accomplished. Roughly $100k was invested ($86.5 in down payments + closing costs) to acquire a portfolio worth $432.5k which yields $8,855 in positive cashflow annually. Basically, this translates to a 9% return on investment: beats the hell out of your neighborhood bank’s CD and the stock market minus its bipolar volatility. The investor’s portfolio is expected to be paid off on your Lender’s schedule in 30 years. At that time, it will consist of three paid off 35 year old homes cashflowing at about 7% of whatever the properties are worth then. In the meantime, your cashflow amounts to little more than a nice bonus/part time income that can support your latte budget, a light bill and a couple of dinners out. So one may think: This strategy doesn’t work! To which I reply: What strategy?!

Real Estate Investing After Blueprint

It all begins with addressing The Timing. Any long term real estate investor is ultimately after cash flow but the real question is When. The overwhelming majority of clients with whom I have this conversation quickly realize that they don’t need the cash flow right now but instead, are looking to build enough cashflow when they arrive at destination. If that’s the case, then what could be accomplished by putting current cashflow to work to bring the destination closer and arrive at a paid off portfolio on your schedule? Glad you asked. Take a look at this (click on the image to see full size):

Meat and Potatoes Oct 21 Blueprint — Click to see full size

What just happened? I crafted a Blueprint investment strategy with those three featured homes using painfully simple but time tested principles. Since the investor doesn’t need the cashflow at the current time, we apply it to the mortgage balance on one of the properties while making the regular payment on the other two. In addition, I advise my client to add $500 from her monthly income as additional catalyst. The goal is to pour gasoline on the fire and obliterate that mortgage as fast as possible.

The result: The first property is mortgage free in 68 months – that’s a little over 5 and half years! What follows is an imitation of what happens in an avalanche. Since the first property is now paid off, the mortgage payment on that property now gets added to the cashflow with which we attack the mortgage on the second property. Since we are hitting it with even higher principal payments, that property is paid off in just 38 months. Rinse and repeat on the third property and voila: the last property is paid of in 35 months.

Moment of Truth

Let’s examine the difference that a well crafted strategy can make. After executing the Blueprint strategy, the investor would “arrive” at a paid off portfolio of properties worth $432.5k (at a very conservative zero appreciation) in 141 months (under 12 years). At that point, the annual positive cashflow would be $30k/year if rents didn’t go up one penny in 12 years. That folks, translates to a 19% annual return on $157k invested every year thereafter. The investor was able to just about triple that $157k in those 12 years leaving appreciation completely out of the picture. Skeptical about the numbers? Email me and I will send you a spreadsheet to look over.

Flexibility

The above analysis assumes perfect execution. But circumstances aren’t always perfect. Don’t want to invest the extra $500/mo? It will extend the journey by three years but lower your capital invested by 40%. So it’s a matter of what’s most important to you, time or money? Want to hold on to the cashflow for a month to ride through a temporary vacancy? You can totally do that. Cashflow of $30k/year is nice but won’t quite cut it? We can increase the asset value from which that cashflow is drawn by acquiring one or two additional properties. This concept is so powerful that detours may change it’s variables, but if you commit to execution, you will look back and won’t be able to stop smiling.

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I can craft a Blueprint investment strategy for you, too. Give me a call at 713-922-2702 and I will get to work. Make this a great week!

How to be successful

October 19, 2011 By Erion Shehaj Leave a Comment

Success is simple. There are a handful of time tested principles that when followed consistently over long periods of time will inevitably cause you to succeed at anything. The funny thing is I’m not about to tell you anything you don’t already know. So then, why do successful people make up such a small percentage of our society? Because while these principles are painfully simple, they aren’t by any means easy.

Photo Credit: Alosh Bennett via Compfight

Success Principle #1: Figure out “why”

If you open a business because you just want to make lots of money, you usually don’t. People that just want their jeans to fit a little better don’t lose weight and keep it off in the long term. The Why is the driving force behind your actions that will push you through when you get stuck. When I meet with a real estate investor for the first time, the first question I ask is why they want to invest. Their first reply usually has to do with semantics: I want another stream of income or I want to build some wealth or I want to take advantage of this market. But when I ask them to dig deeper they find that they’re doing it because if this succeeds their daughter’s college will be taken care of or because they’ve always dreamed of traveling the world with their spouse someday or because they don’t want to end up relying on Social Insecurity (h/t Dave Ramsey) like their parents had to. There’s always a deeper purpose and if you want to be successful, stop here, figure out the why before you worry about how.

Success Principle #2: Have a Plan.

This sounds like a principle straight from the “Duh” Files but it’s amazing how many people are hopelessly pursuing something and they have no clue what. If you don’t know what your Point B looks like even Garmin can’t help you find the way! When it comes to success, vague is the enemy. Know your destination: Set goals and measure progress. Dave Ramsey says goal(s) should be specific, measurable, written, time limited and personal. You will be amazed at what you can achieve if only you sit and write down specific goals, set a deadline for achieving them and measure your progress on the way there. As a real estate investor, having a plan makes the difference between a six figure retirement and just buying a couple of houses for cashflow that couldn’t support your latte habit. That’s why The Blueprint is the cornerstone added value that we provide to our clients. Without it, you’re just making it up as you go.

Success Principle #3: Focus

The power of focus is immense. I am sure you’ve heard stories of people achieving amazing feats by focusing on their goal with intensity. The problem is we live in a society with the attention span of a chicken. We can’t do just one thing anymore. We have to be checking email, playing a silly game, updating our Facebook status and saving the world all at the same time. You don’t believe me? Go to a restaurant, any restaurant and observe how long people can go without checking their smart phones. We can’t even focus on feeding ourselves or just having a conversation, anymore. Don’t let circumstances dictate your actions and turn you reactive. Once your investing plan is in place, you focus on execution. Avoid analysis paralysis, pull the trigger and bring your plan to life. You’ll be happy you did.

Success Principle #4: Do 20% Work

Most people do work that doesn’t really matter. Pareto’s 80/20 principle says that “for many events, roughly 80% of the effects come from 20% of the causes”. Put a different way, 20% of what you do will cause 80% of your results. Do that work and avoid busywork like the plague. Kill or outsource everything else and you’ll never look back. For real estate investors, that means working with a real pro and entrusting them with providing you the data, information and analysis you need to make a decision. Your 20% work is executing your plan – the rest is just distraction.

Success Principle #5: No shortcuts

This principle is by far the most important. In the words of Beverly Sills: There are no shortcuts to anywhere worth going. Know the why, make a plan and execute it. Any attempts to short-circuit the process undermines the results every time. Human nature loves shortcuts: Diet pills to lose 100 lbs in twelve minutes, “proven” systems that will make you a zillionaire by Wednesday, you name it. The truth? You have got to work hard for results that matter and last. Want to change your life and get healthy – you have to eat less and exercise more. Want to be wealthy – you have to spend much less than you make and invest the surplus long term. Captain Obvious would roll his eyes listening to this. But remember, success is simple. You already know all you need to know to win. You just have to execute. It’s simple but not easy.

Numbers never lie. Or do they?

October 11, 2011 By Erion Shehaj 2 Comments

Today’s post addresses a common misconception that costs inexperienced real estate investors thousands of dollars over the long term. When analyzing investment properties, investors have a compulsive need to oversimplify the decision-making process down to a single metric. If the cashflow on the property is X, then it’s a good property. Or if you get X amount of built in equity, you’ve gotten a deal. Because in the end, numbers never lie, right?

A tale of two properties

Let’s say you’re considering two potential investment properties for acquisition. The first property costs $105,000, has $4,100/year positive cashflow and $9,519 Net Operating Income. The second property costs $130,000, has $2,831/year positive cashflow and $9,526 Net Operating Income. Which one is the best investment property to buy? When I pose this question to investors that are just getting started, they almost always pick the first. More cashflow, higher returns on investment, a numerical no brainer. There are several reasons why that’s the wrong decision to make. For starters, an analysis that considers only the “what” without regard for the “why” always yields flawed answers.

Einstein said that “if you judge a fish by its ability to climb a tree, it will live its whole life believing that it is stupid”. Put a different way, if you’re measuring the wrong statistics, you’ll get to the wrong conclusion. More than looking at the amount of cashflow, a smart investor looks at the reasons behind the difference in cashflow. Could it be that the property yielding less cashflow is in a better location/neighborhood than the other? More than comparing returns on investment head to head, a wise investor investigates why one opportunity yields more return. Remember, risk and return are best friends that go everywhere together. Could it be that the property yielding more return is a greater risk? Looking at the naked numbers alone is like picking cars based on the number of cup holders alone. A Hyundai and a Mercedes may have similar engine specs, but there’s a reason for that price difference.

When in doubt

If you’re doubtful about which investing opportunity makes the most sense, here’s a simple rule. Always pick Quality (APQ). Don’t skimp on the quality of your portfolio for a few hundred dollars extra per year. As long as the price to rent ratio makes sense, always select assets that are located in prime neighborhoods: They stay rented longer, attract the best tenants, benefit the most from value and rent appreciation. Look at it this way: If you consistently pick B properties with seemingly sweeter numbers or A+ properties, either way you will arrive to the finish line with a paid off real estate portfolio if you execute a Blueprint. The question is which type of asset would you rather own? Exactly.

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If our investing philosophy makes sense to you and you’d like to talk about putting it to work for you, my number is 713.922.2702. I could be talking with you about this stuff over coffee and coffee makes everything better 🙂

Photo Credit: David Villarreal Fernandez