Long Term Rental Properties

In the path of growth: Exxon’s mammoth campus under construction in North Houston

April 25, 2013 By Erion Shehaj Leave a Comment Tags: path of growth

During the acquisition phase of your Blueprint real estate investing strategy, the temptation is to focus exclusively on well established neighborhoods. But as a neighborhood becomes more and more established, home prices rise and returns drop. So how can you get better returns without sacrificing quality?

You buy properties in the path of growth.

That well established neighborhood of today was at one point not so well established. Needless to say, investors that purchased properties in the neighborhood during that period paid considerably less money for them that you’d have to pay today. It makes perfect sense: At that time, the investment was riskier since no one could know for sure how the neighborhood would turn out. Therefore it was only right that the return should be higher as well.

So, how can we determine which locations and neighborhoods are going to be the popular neighborhoods of 10-15 years from now? More importantly, how can we avoid the misstep that the location we thought had promise doesn’t turn into a dog instead? To get the answers to those questions, let’s take a look a current case study.

Exxon Mobil’s mammoth campus

. There are over 20 structures being constructed on a 386 acre site west of I-45 just south of the Woodlands in what the Houston Chronicle is calling a “mini downtown”. The completion of the project is expected in the middle of 2015. When completed, the complex will house 10,000 employees, 2000 of which will be transferred from Fairfax, VA and the rest will be repurposed Houston employees. The company has already sold its Downtown tower and has put their Energy corridor facility on the market.

That’s great, but what’s that have to do with residential real estate? How does a commercial project of this magnitude impact future growth?

It’s Economics 101. Employment drives demand which in turn drives growth. At the moment, there are about 3000 construction workers dedicated to the project. When the project is complete, 2000 Exxon employees will be transferred from out of state and 8000 Houston employees will probably need to move closer to the area. But that’s not all. Because there are two kinds of employment: Basic and supplemental employment. Two thousand new Exxon jobs are basic jobs which in turn create a multiple of supplemental employment. Here’s how it works: When new jobs are created those families add to the local demand for housing and services. The need homes to live in, grocery stores to shop in, restaurants to frequent etc etc. So, builders will build more (and hire more construction workers), additional commercial shopping centers will be developed and businesses will lease more space. So, the added employment will create added demand which leads to local growth and higher home prices and rents over time.

I’d say the area around this massive project will look very different 10 years from now, wouldn’t you? We can’t know for sure as no one can tell what the future holds but we can be assured that big changes are coming. And we can get on the “train” before it leaves the station and prices get out of reach. We can do that a couple of different ways. We can purchase recently built resale and bank owned homes within a few miles of the project. Or we can build new and take advantage of the warranties and low hassle of a new home. The opportunities are still there even though they’re thinning out as builders and sellers alike try to take advantage of the very thing we’re talking about.

If you’d like to discuss how you can take advantage of buying investment properties in the path of growth as described above, you can call my cell at 713-922-2702 or contact me.

Steve Snodgrass via Compfight

Straight talk on investing in small multi family properties

March 29, 2013 By Erion Shehaj 8 Comments Tags: small multi family

“I know you are against investing in two to four unit properties – but that’s the direction I’m leaning in at the moment” – Theresa said somewhat tentatively.

The overwhelming majority of case studies or portfolio scenarios I’ve written about involve the acquisition of a portfolio of quality single family homes in great school districts. Therefore, it is not at all surprising that some of you might assume I discourage the purchase of other categories of investment real estate.

But the truth is I’m not against investing in any type of investment real estate. Nor do I have a bias to favor single family properties over all else.

So then, why am I advising clients to focus on single family homes when investing in the Houston market?

Our process to identify target acquisitions is deeply rooted in the principles of our Blueprint real estate investing strategy . In a nutshell, we look for quality, recently built properties zoned to great school districts that would attract long term quality tenants and offer solid returns.

To understand why small multi-family properties don’t fit that general standard, one must understand the concept of “highest and best use”. Imagine for a second that you are a real estate developer and you need to make some decisions on what to build on a vacant plot of land. If the land is a corner lot at a busy intersection with lots of traffic near the Galleria, you probably don’t want to build a home on it. There’s a higher and better use for that land than residential property. You might build a commercial shopping center or a single tenant building to house a Starbucks or a bank branch. Instead, if the land is a single lot on a residential subdivision, the highest and best use for it would probably be a residence of some sort.

Since the 1980, the Greater Houston area has experienced the full effects of urban sprawl. By and large, Houston residents don’t mind 30, 45 or 60 minute commutes if that means they could live in a great home with lots of space, 2-3 car garage and a yard. This has been a boon for real estate developers who found themselves with lots of cheap land and good demand for suburban properties.

But they were faced with an important question. If you had 1000 acres of land in Katy to develop residential housing, what was the highest and best use for that land? Should they build a community of duplex properties? Fourplexes? Or single family homes? Really, it was a demand question for the future homeowners that would occupy the properties. If you had a choice Future Buyer, where would you rather live: Duplex, fourplex or a single family home?

For over three decades, the result has been a resounding leaning towards single family homes. In fact, since the 1980’s, there has been very little new development of small multi family properties in the Greater Houston area. The ones that have been developed have quickly turned into outdoors apartment complexes with the wide majority of occupants being renters as owners have transitioned into single family homes.

So the first problem real estate investors face when looking for small multi family properties in the Houston market is a lack of recently built properties zoned to great school districts. What multi family properties exist in these areas are usually built in the 1980’s and bring with them the typical maintenance, repair and capital expenditure problems of older properties.

To illustrate the second problem investors face with small multi family properties, let me tell you about an actual case study. A long term client of ours purchased a four unit property from a bank that had repossessed it. This property needed work but had a lot of positives going for it. The unit mix was great: Two of the units were 2/2 and the other two were 2/1. These were large apartments (over 900sf each) and the building was across the street from three good schools (elementary, middle and high). The price was affordable too – $700 a month for the 2/2 units and $675 for the 2/1 units. Finally, the price to rent ratio was a favorable 5.6 (monthly rent was 1.5% of price) so the positive cashflow on paper promised a great return.

The second problem real estate investors face with small multi family properties in Houston is that proforma numbers don’t match real life numbers.

In order to qualify for a $700/mo apartment, a tenant’s gross monthly income has to be 3-3.5 times rent. So we were renting to tenants that made $24,000-28,000 a year in income before taxes. As a result, there isn’t a whole lot of disposable income there to save and absorb any major expenses (see: unexpected car repairs). To use a common term, our tenants were living paycheck to paycheck. I say this not in a denigrating way whatsoever as we all have been there and know what it’s like. I’m just stating the facts about the situation they face month in and month out. So, when those unexpected expenses showed up (as they usually do) the rent was late or unpaid. That inevitably leads to a much higher eviction rates and turnover of tenants.

The second wake up call came during showings. Prospective tenants weren’t as much interested in the unit itself as they were in the incentives I didn’t know we had to offer. Free rent, no deposit, deposit split into payments are all foreign concepts to those who invest in quality single family properties. Concepts that add much risk to the equation and reduce those paper returns substantially. More importantly, tenants in these properties do not usually commit to long term leases (or in some cases, violate existing leases) because they know there’s always someone offering a juicy incentive around the corner.

Furthermore, when you own a small multi family property you are most likely competing against larger apartment complexes for the same pool of tenants. In most cases, these properties have a competitive advantage over your duplex or fourplex. They can offer tenants amenities that you cannot (i.e. pool, on site management, gated community etc). They have more units so they can offer better incentives. So in the contest for the best apartment tenants they get first pick. And you get what’s left. Many of the applicants you will get have been turned down at the big apartment complex around the corner because they have a broken lease/background check issues/unapproved pets/insufficient income etc. So you are having to lower your tenant standards and keep a blind eye towards these issues if you want a full building. Which brings us to the third problem with owning small multi family properties in Houston – they fail to attract the high quality tenants that our strategy calls for.

Last, tenants that lease apartments have very different expectations of the responsibilities of the Landlord than tenants that lease homes. They expect the Landlord to fix every little thing that ever goes wrong with the property. Therefore, you must have an property management company actively manage the property for you. And when you read “actively” you should imply plenty of repair calls on a regular basis.

So you see, it’s not that I’m against any category of investment real estate. Our strategy lays out very clear acquisition criteria and we take what the market gives us and what the investor’s capital will allow. In Houston, there is no supply of small multi family properties that are recently built which would attract quality long term tenants and produce solid returns. In Houston, at the moment the market is giving us single family properties that fit all criteria and are within reach of the capital our clients possess. Once the capital base of our clients grows to critical mass, the market may give us commercial property with great business tenants. And we will surely make that transition when it’s available.

Other markets may be very different in this respect and small multi families might be optimal there. In that case, I’ll be the first to say, go ahead and invest. But before you pull the trigger please make sure that the property is in a good location and not just in a good enough location. Moreover, make sure that your numbers reflect reality. If you’re using the same assumptions for single and multi family properties, your numbers are wrong. Plan for higher vacancy rates, management fees, lost rent through incentives etc. Finally, make sure that ou have a clear understanding of how much attention a multi family property requires. If you think you can be an armchair investor with a small multi family property, you will find yourself off that armchair shortly after closing.

Matthew Rutledge via Compfight

What is the return on investment for the Blueprint real estate investing strategy

March 11, 2013 By Erion Shehaj Leave a Comment Tags: return on investment, roi

After a workload-induced two week hiatus from writing, I’m back to answer one very frequently asked question. What is the return on investment when you execute the Blueprint real estate investing strategy?

Investors that ask that question are usually trying to compare and contrast investments in different asset classes (stocks, bonds, commodities, life insurance, real estate etc) to make an allocation decision. After all, every investor has a finite amount of hard earned (even harder saved) capital and the quality of their retirement depends in large part on their decision to invest that money wisely.

The final decision depends on four things: The return on investment, the risk involved, the investor’s tolerance for risk and her available investment timeframe. If the investment offers a sky high rate of return but there’s a good chance to lose all your principal, you might want to pass if you have a low tolerance for risk (or possess common sense). If instead, the principal is relatively safe but the return on investment looks up to inflation, you better hope your accumulated capital is enough to hold you as you cannibalize it in your retirement years. Last but not least, the direction you take in your investing is very different if you are 20 years or 24 months away from retirement.

Put a different way, it’s crucial to strike the right risk-return-timeframe balance. And that’s much easier said than done.

Having said that, the question is a fair one. Inquiring minds want to know: If you invest a dollar of capital in a quality asset and hold it long term what should you expect your return to be on that dollar? Real estate investments have the potential to “make the investor money” from four different sources.

Cash on Cash

Cash on cash returns are the perennial investor favorite: Simple and to the point, easy to understand and relatively reliable. The cash on cash return on investment is calculated as the positive cashflow produced by the property (after paying for operating expenses and mortgage payments) divided by the cash investment in the property (down payment and closing costs). Think about it this way – the positive cashflow is the “interest” (or dividend) paid by the investment on your cash invested. When we analyze investment properties for acquisition daily, the projected before tax cash on cash return for each property has to be at least 12%. And this is after we take a conservative approach on incoming rent and operating expenses so in many cases your actual return ends up being higher than what’s in our cashflow projections.

A close cousin to the cash on cash return is the capitalization (or cap) rate. This is the rate of return earned by an investor that owns the property free and clear. For quality locations in good school districts with high tenant demand, we are seing capitalization rates in the 8-9.5% range.

Debt Amortization

Although the cash on cash return is easy, it’s incomplete because it does not account for other returns/benefits the investor receives besides the positive cashflow. One of these benefits is the debt amortization (pay-down) as the investors’ mortgage is paid every month using the incoming rent from the property. It’s easy to forget about this portion of the return since the investor doesn’t “see” this money until the property is sold later on. But that’s more a question of style over substance. Let’s say you acquire an investment property with $100k mortgage at 4% for 30 years. Your positive cashflow at the end of the year is $4700 (a 12% return). During that year, while you were enjoying your “dividend”, your mortgage balance is also paid down by $1761 which amounts to an additional 30% of that annual cashflow.

Capital Appreciation

Ah the good old “A Word” – something one ought not dare use lest they be accused of blasphemy. From 2008 on, disillusioned investors that had been counting on appreciation to right all their fundamental investing wrongs received a pretty harsh punishment from a market that had been pushed passed it’s inflation limit. It turns out that real estate cannot appreciate at 20% annual rates in perpetuity. Who knew?

When you purchase a long term investment property to hold, you effectively control that property and can reap the benefits of appreciation (when and if it happens) which could propel your returns even higher. While a real estate investment strategy that relies solely on appreciation is as flawed as last time it was tried, a more grounded approach that relies on solid positive cashflow and treats appreciation as a additional bonus return is the way to go. But since appreciation is less reliable than Lindsey Lohan on a film set – no one really knows when and if it’s coming, we assume no appreciation on our analyses. If it happens, I don’t think you’ll be very upset with me either way.

Tax Benefits

Finally, real estate investments are afforded special tax treatment in two ways by the IRS which indirectly contributes to your overall return. First, they allow you to take a ghost expense called depreciation, therefore making your cashflow for tax purposes appear smaller than what it was in real life. In so doing, they allow the investor to pay tax on that income at a much lower tax bracket than would have been the case with ordinary earned income. And second, they allow the investor to defer capital gains taxes on the sale of an investment property by rolling the proceeds into the purchase of another investment property. That’s a treatment not afforded to any other investment.

The comprehensive return on investment figure that accounts for all the four factors discussed above is the internal rate of return (IRR). In general, the properties that our clients are buying have IRRs in the 16% range – without accounting for any appreciation during the investment timeframe.

The Wrong Question

I hope that answered your question because I’m here to tell you that it’s a misdirected question altogether. Wall Street has conditioned us to be return centric and compare returns at the watercooler at work. But it’s all inconsistent with the number one rule of investing: Don’t lose the money! Tell me, what use is it to earn double digit returns consistently for years, only to see your principal ravaged by 40% in a major correction? As my mentor and friend Jeff Brown often says, investing is as much about return of investment as it is about return on investment.

Here’s a better measure of performance that aligns with your investing purpose. How about: Will your investment portfolio produce the income you desired when you started investing? If for every dollar you put in, you now own $3-4 in wealth 10-15 years later all while earning a great income, would you care what your percentage return actually was during that period? Take your Wall Street provided blinders off and focus on what’s in it for you. If your investing strategy produced the results you hired it to do, that’s true success.

Ralph Unden via Compfight

Houston market update: Prices and Sales up, inventory drought

February 22, 2013 By Erion Shehaj 1 Comment

Statistics for the performance of the Houston real estate market during January were released a few days ago and they point to a strong Sellers market. All the required ingredients are there: Strong sales, higher prices and inventory levels unseen since Bill Clinton was President (December 1999 to be exact). So let me give you the “espresso ristretto” version of the real estate market stats for January 2013:

Okay great, so what’s it all mean?

The statistic of most importance in this report is the inventory number because it will determine where the market goes from here. At 3.6 months, it’s approaching a level where it may be too low for the market to function normally and it’s likely to cause price increases across the board as Sellers find themselves in the driving seat. Also, this level of inventory is great news for home builders who are likely to benefit greatly from this supply shortage. In fact, they’ve already started to raise their base prices in reaction to these market conditions. Although Buyers may have to pay a little more for their home, this is ultimately good news for the local economy as it will likely benefit from the growth in residential construction.

December and January are typically the slowest time of the year for rentals as most prospective tenants have either completed their move during back to school time around August or they are waiting for Springtime. But the fact that rents rose despite this fact, is an indicator of continued strength of the Houston rental market. Even when compared to the previous three months (1552, 1517 and 1562) the average rent of $1548 in January shows a continuation of the upward trend.

Buyers and Sellers better buckle their seatbelts as the spring seems poised to bring with it a feverish market of high activity, sales, prices and rents.

How to buy investment properties with no money

February 19, 2013 By Erion Shehaj Leave a Comment

A large number of Investing Architect readers get here after googling “how to buy investment properties with no money” every week. Once arrived, they read extensive articles about our Blueprint real estate investing strategy in which long term real estate investors employ their hard saved capital to build a solid stream of retirement income using quality real estate investments. At first glance, the two are thoroughly incompatible – on the one hand, there are aspiring investors who seem to want something for nothing and on the other an investment strategy that requires extensive resources they don’t possess. But things aren’t always as they seem.

First, let me start by saying that the beauty of our human ability to dream is that it doesn’t require the possession of resources necessary to fulfill that dream. In other words, just because you might not have the capital to invest in real estate and assemble a sizable portfolio, that shouldn’t prevent you from aspiring to it. In fact, this country was built on its people’s incredible ability to make something from nothing. To take a humble beginning and transform it into a success story that boldly defied its initial odds.

But there’s a fundamental difference between wanting to make something from nothing and wanting something for nothing. There are strategies and detours that investors in the first category can take to better their position – and I will share one of those strategies later in this post. But for those that feel entitled to something for nothing – to “investing without investment” – I’m afraid that I have nothing to offer but an attempt to change their mind and their course.

So let’s get deeper into the details. Let’s say that you want to invest in real estate but you have very limited capital. You’d love to purchase a quality investment property in a good location and hold it long term but you don’t have enough money for the required down payment. What are you to do? First, you must understand that real estate, when properly employed, is an excellent vehicle to take your existing capital and make it grow and produce a solid income stream. It is not a great vehicle to create your capital despite what investing books from various gurus will tell you.

Your menu for investing in real estate using the proverbial “other people’s money” is made up of very limited options – none of which are very good for you. For instance, you can try wholesaling: Find a property being sold below market value, get it under contract then assign that contract to another investor for what you paid plus a profit for you. This is the least risky option although it is a overly saturated market and requires an amount of time you might not have unless you quit working. Or you can buy properties subject-to: Find a good property where the owner cannot keep up payments or wants to sell and control the property by taking over his payments. This works great until you discover that the loan whose payments you took over specifically prohibits such assumption without explicit permission from the Lender. If they discover it, they have the right to call the entire loan due on the spot and often do when the market softens. Finally, there’s the guru’s special – Start flipping houses using short term hard money loans at almost usurious rates and fees. Yeah that makes perfect sense for an investor with no money – said nobody ever!

Criticism is fine when backed by facts but it’s hollow when it’s not followed by solutions. So here’s a better strategy for the real estate investor who is just getting started with very limited capital resources. When money isn’t available, you have to bring other resources to the table: namely, time and flexibility. Let’s say you have managed to save $5-7k – not nearly enough to purchase an investment property with 20% down. However, you can acquire a primary residence with as little as 3-5% down (depending on the loan program for which you qualify) and get the Seller to contribute towards your closing costs. So here’s the plan: Purchase a recently built home as a primary residence with the minimal down payment but make sure that you’re picking that home for how it would perform as an investment when you decide to turn it into one. Also, make sure the home you purchase is as close to move in ready as possible – avoid homes that require work. Live in the home until you are able to save enough money for the next property but no less than 9-12 months. At that point purchase another property using the same criteria and rent out the first home. You can rinse and repeat this process 3-4 times over a 5 year period and accumulate a small investment portfolio using the same capital it would take you to purchase just one investment property with 20% down. Throughout the process, make sure you can comfortably afford the payments and that you keep an emergency fund for repairs. It’s a strategy that carries a higher risk than putting down 20-25% on each property but it’s much more sound than the “no money” alternatives. It requires your flexibility to move multiple times in a 5 year timespan and plentiful time but remember that those are the resources you bring to the table to compensate for the capital.

Reza via Compfight

Real estate investing and authentic Italian pizza

February 12, 2013 By Erion Shehaj

A couple of years ago, an American friend of mine went on vacation to Italy with the family and he tried authentic Neapolitan-style pizza for the first time. He was speechless! The pizza amounted to a unique culinary experience and had nothing whatever to do with its gooey American counterpart he had taken out thousands of times. “How is it possible – he asked the shopkeeper – that something made the same way from the same ingredients, can be so deliciously different?” The shopkeeper’s answer was as brilliant as it was obvious (feel free to read this in an Italian accent in your mind) :

Well, there can only be three reasons why the pizza is better: The ingredients, the oven and the cook.

The wise shopkeepers words make for great real estate investing advice. When you invest in real estate long term, the difference between success and failure also comes down to the ingredients, the oven and the cook.

Ingredients

At first glance, one might think that authentic pizza has the same ingredients as its American cousin. But this couldn’t be further from the truth. From the hand kneaded and tossed dough, to the San Marziano tomatoes that make up the sauce and the fresh mozzarella di buffala – everything is superior. The unique textures and flavors that come as a result simply cannot be replicated without using similar quality ingredients.

In real estate investing, the “ingredients” are the properties inside your portfolio. As in the pizza example above, a fleeting glance at two portfolios might lead you to believe that they’re one and the same. But a closer look will reveal that properties inside a successful long term investor’s portfolio are at an entirely different level. The quality of the school district and location is much higher in a successful portfolio. The neighborhood amenities and proximity to thoroughfares and shopping are better. And most importantly, they are that way on purpose. A successful real estate investor knows the type of tenant she is trying to attract and what those tenants look for in a rental property – and she buys properties that fit that profile and produce good returns. No matter how knowledgeable an investor you might be – there is no way to replicate the performance of a quality real estate investment portfolio by using inferior properties. So, here’s a guide on how to find great investment properties.

Oven

But ingredients alone aren’t sufficient to make an authentic Italian pizza. In fact, if you took those same ingredients and tried to bake it in your home oven, the results would be underwhelming. Authentic pizza requires an oak fired, stone oven that heats up to 905 degrees Fahrenheit.

In real estate investing, your oven is your overarching strategy. We call ours, The Blueprint. Without a solid strategy that is tailored to your goals, you won’t reach them even if you manage to buy the right type of properties. What makes a real estate investing portfolio tick is how all the assets within the portfolio work with each other. If you buy good properties but they aren’t weaved in a good strategy you lose the synergy that compounds the success. As a basic example, if you purchase 40 year old properties in good locations with good school districts, you won’t reach retirement by the target date because the increasing capital expenditures (major repairs) will eat up the cash flow.

Cook

And yet, even with the right ingredients and the right oven, there’s one more piece missing. You still need a great cook with the know-how and experience to make great pizza. The speed and pressure during the kneading process, the hand tossing, the thickness off the dough etc. are all dependent on the skills of the cook. The final result won’t be the same if the cook is an amateur.

In real estate investing, the cook is the person advising you about your real estate investments. Or it could be the investor herself if they’ve chosen the DYI route. So let me ask you, who’s advising you about your real estate investments? Is it someone who’s just a couple of chapters ahead of you in the book, or a true pro that brings value to the table every step of the way? And if you’ve been flying solo, how’s that been working out for you? Are you on track to achieve your goals or have they been swept aside because you don’t think it can be done? I’m here to tell you that it can – but you need the right “cook” alongside you.

Sebastian Mary via Compfight