FLIPPING OR HOLDING MULTI-FAMILY PROPERTIES

A positive result of rehabbing a multi-family property is that you have an automatic “plan B.”  Once you are done you can decide whether to flip it for an immediate profit or hold it for rental income.  There are a number of considerations and calculations you must examine when making that decision.

There are calculations such as cap rate, cash on cash return, rent as a percentage of purchase price, rent percentage of purchase price plus rehab cost and the ratio of operating expenses to operating income.  Debt service coverage ratio becomes particularly important if you are thinking of conventional financing through a lender or refinancing after some experience with renting the property.  Be aware that any multi-family less than 5 units would not be viewed as commercial property by a conventional lender.  That generally means that you will have to show the lender that you are capable of handling the debt by disclosing your personal income and source of funds.  In a commercial transaction you can usually get the lender to consider the income producing property as a stand-alone business without you having to worry about what your personal income is.

Let’s look at some of these numbers.  Cap rate (capitalization rate) is calculated by dividing the annual net operating income by the purchase price of a property (or possibly market value).  So, if a property net operating income is $20,000 (which does not include any mortgage or debt used to finance the purchase of the building) and the building is selling for $200,000 then the cap rate is 10% or 10.  $20,000 divided by $200,000.   For smaller rentals I personally do not pay attention to cap rate.  If there are 6 or 7 units in the building I will ponder it, but if it may not be a deal killer.  In areas like Manhattan or Fairfield County, CT you will find very low cap rates 2, 3 or 4 may not be uncommon.  Buyers of these properties are often looking more toward appreciation then what their return in current income is going to be.  Cap rates in less affluent areas will normally be in the double-digit ranges for good deals.  But again, it is not the only thing to consider.  Generally it is felt that the higher the cap rate the better the deal you are probably getting.

I think cash on cash return should be a consideration in a multi-family buy and hold situation.  After all, if you only get a 3 or 4 percent return on your money then there are probably better secure investments for you.  I calculate the cash on cash by taking the actual cash flow on the property and dividing that by the actual cash you use to purchase the property.  So, if the net operating income on a cash basis is $20,000 in the first year and you then deduct your loan payments, let’s say $10,000 for the year, you have $10,000 of cash flow.  If you had to come up with $40,000 cash to get the building, then your cash on cash return is $10,000 divided by the $40,000 you needed to get the building, or 25%.  That looks like a pretty good use of your cash.

I consider rent as the percentage of the purchase price and the purchase price plus rehab to be a “must compute” type of calculation for analysis and holding rental property. At a minimum, I am looking for the monthly rent to be equal to or exceed 1 percent of the cost of the property.  At one percent I am not crazy about the deal, but if the current rents are too low and I think they can be raised or increased by getting new tenants I would consider the building.  If you can get a 1.5 to two percent rate I think you are doing very well.  So, let’s look at the calculation.  Again, we will say the cost of the building is $200,000.  Let’s say we get $3,000 in rent each month.  The rent as a percentage of the price of the building is $3,000 divided by $200,000 or 1.5%.  This, for me, is acceptable.

I do not like to see operating expenses being more than fifty percent of the operating income.  I include it that calculation a reasonable estimate for vacancy loss as well as a reserve amount.  This calculation with the rent loss estimate and reserve amount included in expenses is probably too conservative for many multi-family investors, but that is a personal preference and I am always willing to consider the pros and cons of this calculation given current market considerations and longer term projections.

The last calculation I will mention is the debt service coverage ratio.  As I mentioned before, if you are looking for conventional refinancing or a bank loan this is an important calculation to a lender along with the cash flow.  Most lenders that I have talked to are looking for a 1.2 or 1.25 ratio.  Some may go with a lower ratio, but plan on a 1.2 or1.25 minimum requirement.  The debt service coverage ratio is the net operating income amount divided by the loan payment amount.  So, if we have $20,000 of net operating income, (which must consider vacancy loss, which should automatically be accounted for when using actual numbers), and our annual loan payments total $15,000 the ratio is $20,000 divided by $15,000 or 1.33, which is acceptable. Presented on a monthly basis, the monthly net operating income is $1,667 divided by $1,250 which is 1.33.  This would be considered an allowable ratio.  So, if the lender was confined to a 1.2 ratio or better, and wanted to see what the maximum monthly allowable loan payment is, the lender would take the $1667 monthly net operating income and divide that by 1.2 to say the maximum allowable loan payment allowed would be $1389 per month.  In this example the monthly loan payment of $1,250 is perfectly acceptable.

Using a spreadsheet when considering multi-family properties before you make a deal allows you to properly estimate your annual income and expenses and then calculating these rates, ratios and numbers. This will help you make a more informed and intelligent decision when considering your alternatives before purchasing a multi-family property that needs work.

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TRAINING ON HOUSE FLIPPING: A SYSTEM FOR FLIPPING HOUSES

Visit https://www.propertycoach411.com/ for information on training.  One on one, group training or training materials.  There will be live group training in Connecticut on October 14, 2017 from 9 in the morning until 6 in the evening.

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to get information on  developing a system for flipping or wholesaling properties.

On Amazon for Kindle or in Paperback

 

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CALCULATING OPTIONS FOR MULTI-FAMILY OWNERSHIP

There are a variety of calculations and numbers to think about when considering your options as to whether you should retain or sell a multi-family property that you are rehabbing.    It is always good to have a variety of exit strategies, and multi-family rehabs can give you that without much thought.

So, there are calculations such as cap rate, cash on cash return, rent as a percentage of purchase price, rent as a percentage of purchase price plus rehab cost and the ratio of operating expenses to operating income.  Debt service coverage ratio becomes particularly important if you are thinking of conventional financing through a lender or refinancing after some experience with renting the property.  Be aware that any multi-family less than 5 units would not be viewed as commercial property by a conventional lender.  That generally means that you will have to show the lender that you are capable of handling the debt by disclosing your personal income and source of funds.  In a commercial transaction you can usually get the lender to consider the income producing property as a stand-alone business without you having to worry about what your personal income is.

Let’s look at some of these numbers.  Cap rate (capitalization rate) is calculated by dividing the annual net operating income by the purchase price of a property.  So, if a property net operating income is $20,000 (which does not include any mortgage or debt used to finance the purchase of the building) and the building is selling for $200,000 then the cap rate is 10% or 10.  $20,000 divided by $200,000.   For smaller rentals I personally do not pay attention to cap rate.  If there are 6 or 7 units in the building I will ponder it, but if it may not be a deal killer.  In areas like Manhattan or Fairfield County in Connecticut you will find very low cap rates 2, 3 or 4 may not be uncommon.  Buyers of these properties are often looking more toward appreciation then what their return in current income is going to be.  Cap rates in less affluent areas will normally be in the double-digit ranges for good deals.  But again, it is not the only thing to consider.

I think cash on cash return should be a consideration in a multi-family buy and hold situation.  After all, if you only get a 3 or 4 percent return on your money then there are probably better secure investments for you.  I calculate the cash on cash by taking the actual cash flow on the property and dividing that by the actual cash you use to purchase the property.  So, if the net operating income (cash basis) is $20,000 in the first year and you then deduct your loan payments, let’s say $10,000 for the year, you have $10,000 of cash flow.  If you had to come up with $40,000 cash to get the building, then your cash on cash return is $10,000 divided by the $40,000 you needed to get the building, or 25%.  That looks like a pretty good use of your cash.

I consider rent as the percentage of the purchase price and purchase price plus rehab to be a “must compute” and analyze type of calculation for holding rental property.  At a minimum the monthly rent must equal or exceed 1 percent of the cost of the property.  At one percent I am not crazy about the deal, but if the current rents are too low and I think they can be raised or increased by getting new tenants I would consider the building.  If you can get a 1.5 to two percent rate in moderate income areas I think you are doing very well.  So, let’s look at the calculation.  Again, we will say the cost of the building is $200,000.  Let’s say we get $3,000 in rent each month.  The rent as a percentage of the price of the building is $3,000 divided by $200,000 or 1.5%.  This, for me, is acceptable.

I do not like to see operating expenses being more than fifty percent of the operating income.  I include in that calculation a reasonable estimate for vacancy loss as well as a reserve amount.  This calculation with the rent loss estimate and reserve amount included in expenses is probably too conservative for many multi-family investors, but that is a personal preference and I am always willing to consider the pros and cons of this calculation given current market considerations and longer term projections.

The last calculation I will mention is the debt service coverage ratio.  As I mentioned before, if you are looking for conventional refinancing or a bank loan this is an important calculation to a lender along with the cash flow.  Most lenders that I have talked to are looking for a 1.2 or 1.25 ratio.  Some may go with a lower ratio, but plan on a 1.2 or1.25 minimum requirement.  The debt service coverage ratio is the net operating income amount divided by the loan payment amount.  So, if we have $20,000 of net operating income, (which must consider vacancy loss, which should automatically be accounted for when using actual numbers), and our annual loan payments total $15,000 the ratio is $20,000 divided by $15,000 or 1.33, which is acceptable. Presented on a monthly basis, the monthly net operating income is $1,667 divided by $1,250 which is 1.33.  This would be considered an allowable ratio.  So, if the lender was confined to a 1.2 ratio or better, and wanted to see what the maximum monthly allowable loan payment is, the lender would take the $1667 monthly net operating income and divide that by 1.2 to say the maximum allowable loan payment allowed would be $1389 per month.  In this example the monthly loan payment of $1,250 is perfectly acceptable.

Using a spreadsheet to estimate your annual income and expenses and to analyze a deal before you acquire a multi-family property is a must.   Then calculating these rates, ratios and numbers based on your findings will help you make a more informed and intelligent decision when considering your alternatives before purchasing a multi-family property that needs work.

OPTIONS FOR MULTI-FAMILY HOUSING NEEDING REHAB

Let’s talk about multi-family housing that needs rehab work.  Obtaining a multi-family that needs work gives the investor a variety of options for both financing the property as well as deciding to flip, buy and hold or buy and hold for a period of time then flip.

METHODS OF PURCHASING MULTI-FAMILY HOUSING

You can always take the conventional route when buying multi-family properties.  By that I mean you can get a mortgage from a lender.  If the property has enough units to be considered a commercial real estate deal (generally more than four units is considered commercial) you can usually get a mortgage based on the income the property generates on its own, without having to prove your own personal income.  If you are buying the property that is in disrepair or has vacancies you will probably not be looking at conventional financing.  If you are not sure if you want to flip or buy and hold, this may not the best way to go.  The expenses of appraisal and closing costs are far too high to consider this economically feasible.  In addition, you may find that a conventional lender will insert a prepayment clause which will make a quick turnaround prohibitive.

There are some hard money lenders who will be willing to finance multi-family properties whether you decide to flip them or hold them.  Again, the rates on these loans may make it prohibitive.  The best sources of funds for buying these properties then boils down to your own cash, private lenders or OWNER FINANCING.

You can often sell your idea of owner financing by simply putting the right information in front of the current owner.  For example, you can make a cash offer at the low end of the spectrum.  You can make an offer subject to obtaining a mortgage at a little higher amount.  Finally, you can make an offer that cannot be refused, by offering asking price or higher, but that offer is on the condition that the owner finance a major portion of the purchase.  You can show the owner how the interest rate you are offering is better than most investment returns he will get elsewhere.  He will have a first position mortgage on the property that will allow him to take back the building in the event of default, and you can have the owner give you a long-term repayment schedule (say 20, 25 or 30 years) with a balloon payoff to the owner after five or ten years of payments.  Show that information to the owner on paper.  Let them see that, in fact, he or she will be making more than what the actual purchase price is because of the interest being collected over the five or ten years of repayment.  If you decide to flip the property there is nothing lost in the transaction, and you have minimized your cash outlay by getting the owner financing in place.

Of course, all of this is predicated on running numbers for both flipping and buying and holding before you even get into the idea of buying the property.  So, we have previously discussed some things about running numbers in the event of flipping.  In a future blog we will look at some numbers and calculations you must be aware of in order to make a decision on a possible buy and hold option.

There are a number of additional and traditional calculations to take into account when considering a buy and hold option on a multi-family rehab project.  I personally do not give the same amount of weight to the importance of some of these numbers as others often do, and I will try to cover that as I discuss each item and the importance of each calculation in my next blog.

You are already ahead of the game by purchasing a multi-family property below market.  The planning for this rehab should generally be a bit different than what you would do for a single-family home that you would be selling to homeowners.  Rental property generally should be viewed with a bit different perspective.  For example, do you put in granite countertops?  It is not likely that you would do that.  Likewise, you may want to use linoleum where you might otherwise tile, or use a variety of flooring instead of hardwood if the hardwood is not already there.

 

TO FLIP OR RETAIN MULTI-FAMILY PROPERTIES FOR INCOME

 

 It is becoming more and more apparent that knowing the ins and outs of house flipping allows the investor to increase his or her possibilities for making the most out of an investment.  A perfect example of what I am talking about is when an investor, who is familiar with house flipping and the costs associated with that process, purchases a multi-family property with the original intention to flip.

Not so fast!  Before you decide to flip that property, I suggest that you review the benefits of possibly retaining the property.  Before we examine what you must know to make an informed decision about keeping the property or flipping it, let’s consider some alternative methods of purchasing the property that may or may not be available to you if you are dealing with a single-family flip.

Generally, if you are flipping a single-family home, you can finance the purchase and rehab of that home by using your own funds, using private money or using hard money.  You may be able to convince the owner to finance the property while it is being upgraded, but I would say that would be rare.  Most houses that will be worth flipping for a good profit are houses where the seller is quite motivated and is looking to cash out more quickly.  The original owner may not be willing to wait for you to fix the house and then sell it, which can take a number of months, and has an unknown end date for both you and the original seller.

Other problems can be created by the original owner waiting.  If they have any idea of the profit you may make you can find yourself at odds with them.  This could jeopardize the project and lead to the entire project becoming a bone of contention. Will there be profit sharing?  If so, how will that be determined?  If not profit sharing will the original purchase price need to be adjusted?  What happens if the profit is somewhat different than what you anticipated, (either more or less) as a result of you running the project?  Also, would the original owner be willing to deed the house to you before getting paid-in-full?  Would they be willing to allow you to tear the house apart and rehab if they do not turn the deed over to you, or they are not sure that you will finish the job or pay them the remainder?  Will you leave the house half done and walk away with less to lose then what they may lose?   Owner financing for a single-family home that is being flipped is difficult to come by, to say the least.

Our next blog will move into the discussion of multi-family housing that needs rehab work.  Obtaining a multi-family that needs work gives the investor a variety of options for both financing the property as well as deciding to flip, buy and hold or buy and hold for a period of time and then flip.

USING A TRUST WHEN OBTAINING PROPERTIES

Should you use a trust for real estate transactions??

Posted by Property Coach on Saturday, August 5, 2017

Concerns When Your Flip is Ready to Sell

There are a few things that you must be aware of and concerned with when your flip (house) is ready to sell.  When you “think” you have completed rehabbing a house and are ready to put it on the market be aware of some possible pitfalls and snags. 

First, you should have a punch list.  Go through the house to be sure everything is complete.  I have found that there is a tendency for many contractors to not be concerned with the small stuff.  For example, be sure that everything is painted and touched up.  Be sure all the doors close properly and all the door knobs are on correctly.  Is all the trim completed? 

In addition to the punch list being completed, you must get lien waivers from all the contractors who worked on the job.  You should do this before you hand them their final check.  This is a very important step for you so that you don’t unexpectedly have any legal issues with liens just before closing.

Two things to deal with once you have an offer on the house.  One is the inspection, and the other is the appraisal.  Many people will leave something obvious for an inspector to find just so he can justify his fee.  You should be sure that you have checked all of the mechanicals to be sure things are hooked up properly and working.  The boiler or furnace, hot water heater, all plumbing is working properly and there are no leaks, the electrical upgrade is done and the panel is properly labeled.  Smoke alarms and carbon monoxide detectors are hard-wired and have been tested.  Any fire prevention requirements have been completed as well.

When the appraisal is being done try to have your realtor on the premises or you be on the premises.  Be sure not to get in the appraiser’s way and do not annoy them.  You should be ready to answer questions and you may want to be sure that you and your realtor are prepared with comps to offer the appraiser in the event that he does not see a value as high as you have determined.

Paying attention to these things will help to prevent issues that may hold up the closing.  Do what you can to help the process run smoothly and get it done as quickly as possible.

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IRC Section 1031 Like-Kind Exchange For Real Estate Investing

Real estate investors should be somewhat familiar with the IRC Section 1031 like-kind exchange rules.  It is important to talk to your tax professional if you are considering selling investment property and getting (replacing it) with another property. The IRC Section 1031 rules allow favorable tax treatment when a like-kind exchange of certain assets occurs.  You are allowed to defer gains on the sale of an asset if it is replaced with like-kind property.  It is a tax deferral, not a tax free exchange.

This exchange must be done within prescribed time periods.  Basically, there are two time periods you must follow.  The first requires you to identify a replacement property within 45 days of disposing of the first property.  Identifying means a written agreement that should be delivered to the seller.  The second time element is the requirement that you must acquire the replacement property within 180 days of disposing of the initial investment property.  There is a bit of a catch to the 180 days.  It must be acquired within the 180 days or before you tax return for that year is due, whichever is less.

Depending on the way the exchange is done, your transaction may require a third party intermediary or facilitator. Per an IRS release,  “It cannot be someone that you have used within the past 2 years.  You cannot act as your own facilitator. In addition, your agent (including your real estate agent or broker, investment banker or broker, accountant, attorney, employee or anyone who has worked for you in those capacities within the previous two years) cannot act as your facilitator. ”

When you do qualify for the IRC Section 1031 like-kind exchange you must report that on your tax return using IRS Form 8824.

I am attaching a link to an IRS document which provides clarification and publications references pertaining to this issue.

https://www.irs.gov/uac/like-kind-exchanges-under-irc-code-section-1031

 

Rehabbing a Bathroom

Rehabbing a bathroom is an important step in a fix and flip situation.  Generally, if you want to get the best results you will find yourself replacing toilets, sinks, bathtubs, tile, flooring, tubs and showers.  You have to be careful about how much you spend in a bathroom makeover.

Prices for tubs, showers, sinks, tile and toilets vary tremendously.  When flipping you want the bathroom to look great.  You also do not want to use products that look cheap.  You need to find decent materials that will look great and will last for a reasonable amount of time.

Kitchens and bathrooms are probably the two rooms that need the most attention when flipping.  Sometimes you will find a bathroom with porcelain tubs and tile that may look worn but really doesn’t have anything wrong with it.    These items may even be a better quality,  when originally installed ,then the products that you intend to use for the flip.  Instead of ripping it out the old items consider refurbishing the tub and tile through a glazing process.  Redoing the coloring and glazing in a tub and on tile will make the bathroom look as new as replacing those items.  You can also change the colors.  There are a number of people who do this, and a good job could save you some cash, which means more money in your pocket.

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Have a System for Success

Have a System for  Success

 If you have a system for when flipping you are more likely to be successful.  Have a system for success. There are never any guarantees for success, but you can mitigate the potential for failure by having a system.  I have been thinking about some people I know who have not had a very pleasant experience flipping a house.  As I looked at their situations one thing became evident to me.  The people who had the most trouble and who were not successful did not have a system. 

Think about it.  The most successful businesses are system based.  McDonalds, Dunkin Donuts, other fast food restaurants that are franchises are successful in large part because they have systems.  Franchisees are required to follow the system of success.  Procedures and business practices are consistent within each business.  These systems have been developed over time to breed success.

The same idea is a requirement for a successful flipping business.  A system for flipping success gives you a leg up on others who do not have a system and reduces the chances of having a bad experience.  To put it bluntly, you are reducing your likelihood of failure.  Having a system increases your chances for success and improves the likelihood of having a pleasant experience. 

The system for flipping must include everything from the business startup to searching for a house that will be profitable, to hiring contractors, having the required legal documents, knowing what materials to choose and selling the house when it is finished.  This list is not all encompassing, but is food for thought if you are considering flipping houses. 

So, before you begin to flip a house, be sure all of your ducks are in a row.  Know what you are going to do before you do it.  Have a system and be successful.

I am known as The Property Coach and I teach my coaching students a system that gives them a good chance of being successful.  I can be reached by email at propertycoach411@gmail.com.