Final Walk-Through

FINAL WALK-THROUGH

As you go through your real estate investing you may feel that a final walk-through of your new purchase may not be necessary.  If you are buying a flip house that you have been in a couple of times and you know it is empty, there is a temptation to skip the final walk-through.

Do not skip the walk-through.  Be sure you or someone who works with you does a walk-through.  You may think that there is no sense to this because you are buying the place as is, you know it needs lots of work and you know it was trashed.  After all, that is why you got such a good deal on it, right?  That is true, but I will explain to you why this is important and what happened to me once when I decided to forego the chance to see the place a couple of hours before I closed on the deal.

I went to my closing, knowing the owner had moved out weeks before.  The house needed quite a bit of work.  The person living there had not cleaned the place for months, if not longer.  The owner was also a hoarder.  I really didn’t feel up to going through that place again.  At the end of the closing I was told that the key had been left on a kitchen counter.  So, I guess that meant that the house had been unlocked for weeks.

I decided to go to the house immediately after the transaction had taken place to revisit what I needed to do to get started and to lock up.  When I got there all the doors and windows were locked.  I figured the guy had locked the key inside, so I was trying to decide how to get into the house without causing unnecessary damage.  I had already tried the front and back door, and as I stood there thinking about my dilemma, a woman came to the front door!  What?!!

In a matter of weeks, having an unlocked vacant house, I had inherited a squatter!  I wasn’t sure she knew how hard or how easy it would be for me to get her to leave.  I have a real problem being mean, but after all, this was my business.  I advised her that she could not stay, and somehow I convinced her to leave, at least for a while.  I immediately changed all of the locks.  When I had another conversation with her I told her that she had until the next afternoon to come and pick up her belongings.  If she wasn’t there by the drop-dead time I gave her, I would put everything on the curb.  I had a tough time with this, but it was a result of my own doing.

I was fortunate that she did not press the issue of leaving, and she did show up to get her belongings.  If she had given me a hard time, it may have been weeks or more to get her out of that house.  If you do what I did, you may not be quite so lucky.  Do your final walk-through.  This will give you a chance to hold up the closing if you find an issue that had not been noticeable earlier, or if you find what I did, a squatter.   

Tax Liens and Tax Deeds

TAX LIENS AND TAX DEEDS

 Tax liens and tax deeds should be a serious consideration if you are thinking of investing in real estate.  Each state has its own set of laws and rules when it comes to tax liens and deeds.  You should make yourself familiar with those laws and rules in any state where you are considering investing in a lien certificate or deed.

Tax liens occur when a property owner fails to pay the property taxes that are due on a piece of property that he or she owns.  Once a certain amount of time passes after a tax payment becomes delinquent, the taxing authority can place a lien on the property.  The taxing authority, of course, must collect taxes in order to provide the services needed in that community.  If they do not collect the tax they will not have the funds to provide those necessary services.  To be sure that the taxing authority can collect funds they will sell tax lien certificates to investors.  The certificate will include past due tax, any penalties and interest.  The interest rate will depend on the state and the format of the auction that is conducted when selling the certificates.  If the property owner pays the amount due to the taxing authority in the prescribed amount of time (the redemption period), the taxing authority will then pay the tax lien certificate holder (the investor) the principal, penalties and interest.

A tax deed purchase is when you actually acquire title to property at the tax deed sale.  Generally, in most tax deed states, you will own the property free and clear of any other encumbrances that may have existed on the property.  In a pure tax deed state once you, the investor, own the property the prior owner has no right of redemption.    

As mentioned, some states are tax lien states.  To be clear, in a tax lien state you do not acquire ownership or title to the property.  Some states are tax deed states.  In a tax deed state you acquire ownership and title to the property. 

There are a number of states that are considered hybrid states.  Their process is a mix of tax liens and deeds.  For example, Connecticut is a hybrid state.  You can actually acquire title to the property but it is subject to the prior owner having the right to redeem (by paying the back taxes, interest and any penalties in full) within a six-month period, and getting the property back.

Tax liens and deeds can be a lucrative investment.  You can earn as much as 18 percent or more, or even come away with property that is worth much more than what your capital investment is.  When you know what states you have an interest in you should research the process and properties before you bid.  If you are investing in a lien or hybrid state you must know how long your money may be inaccessible to you.  Don’t give up.  You may find that there is heavy competition in some areas, but if you can get in the game it can be lucrative.

Cash on Cash Return – Maximize Your Investment Earnings

CASH ON CASH RETURN – MAXIMIZE YOUR INVESTMENT EARNINGS

Maximizing the cash on cash return on a real estate investment is what all investors should want.  People often wonder how others have done so well with real estate investing.  There is often an assumption that people who have accumulated wealth through real estate investing must have started with a good deal of money, got in at the right time, inherited property or had lots of cash.

Many people who have created wealth in real estate have done so by being creative or understanding how to maximize the return on their real estate investment.  Maximizing the return on real estate investments can be accomplished in a number of ways.

Many investors know that using leverage is a way of getting into real estate in a bigger way then just using available cash.  Leverage is basically using borrowed money to buy the real estate.   Buying rental property with the help of a conventional mortgage or negotiating owner financing are ways of using leverage.  Leveraging your investment increases your cash on cash return.

You determine your cash on cash return by taking your net cash revenue (cash in minus cash out) and dividing it by the cash you had to use to acquire the rental property.  For example, let’s assume you buy a 3-family house for $200,000.  You have $40,000 as a cash down payment and you finance the remainder.  Assume too, that the property generates a net cash flow of $1,000 a month, or $12,000 per year.  Your cash on cash return is the $12,000 divided by the $40,000 cash used to buy the property.  This gives you a cash on cash return of 30%.

Now let’s you had paid all cash for the building.  Also, let’s assume your mortgage payment in the prior example was $1,000 per month.  Now you wouldn’t have to pay a $1,000 per month mortgage payment.  In this example, your cash increases by $1,000 per month.  Therefore, your cash on cash would be $24,000 net cash flow annually divided by the $200,000 used to buy the property, or a cash on cash return of 12%.  Still a good return, but not the rate that you get when you use leverage, as the 30% cash on cash rate of return in the first example indicates.  The fact that you have used leverage (borrowed capital) in the first example shows that you have maximized the return on your cash investment.

As time passes refinancing rental property can allow the owner to take money out of the property and purchase more rental units.  The ability to refinance a building and remove cash is a result of appreciated value on the property as well as paying down some of the original debt.  Also, refinancing a larger percentage of the value of the building then what was originally financed increases the amount that can be taken out of the deal.  In other words, if you originally financed 80% of the appraised value and you can now refinance 90% of the appraised value, you are financing an additional 10%.  Even in a situation where there is no change in the value of the building you conceivably can to take out money through refinancing.

An investor can also obtain property that is turn-key and has positive cash flow.  Turn-key is obtaining property that needs no work and little effort on the part of the owner.

The actual after tax return on any real estate investment can be increased if the funds used to acquire the property are within a Real Estate IRA, which can accumulate earnings tax free.  In this approach financing can also be obtained to free up funds for another investment. Howerver, if you are using an IRA to buy the property and also have the property mortgaged you must be aware that there is a distinct tax treatment you must follow.

Hard Money Lenders

HARD MONEY LENDERS

A Hard money lender is a lender who loans money to real estate investors.  Typically the lending period is a short period of time, generally not more than one year, and the interest rates are quite high.

Hard money lenders do have a place in the real estate investment game.  Most flippers, and sometimes landlords, take over property that is not acceptable to a bank for a conventional loan or mortgage.

The use of a hard money lender in a house flipping business is quite common.  The flipper has purchased a house that needs work.  Obviously, for the flipper to buy the house, it is a home that does not command getting sold for a price that would be the normal selling price of the house if it was in reasonable condition.  The flipper has no intention of keeping the house long term, but needs some additional funding to either buy the property or to do the updating and rehabbing work.  A bank will not finance a house in this condition for a short period of time.  In addition, a conventional lender would have too long of a process to obtain the funding.

The whole business plan of a house flipper is to get in, fix it and get out as soon as possible.  Generally a hard money lender can accommodate this need.  They are niche lenders and can do quite well when lending to the right people in the right location with the right value being placed on the property.

If you have ever used a hard money lender you know that the interest rates you find are high.  I have seen rates as high as 5 points and 15 percent ranging down to 3 points and 9 percent.  The most frequent rates that I have seen are 3 points and 12 percent and 2 points and 10 percent.

Usually the hard money lender will require that the borrower have some “skin in the game.”  By that I mean they want to see the investor have some of his or her own money at risk, which is an indication that they will not walk away from the investment.  Also, most hard money lenders want a first position mortgage, and may not allow second mortgages.  They often require payment of monthly interest while the project is a work-in-progress, and they will deduct the points that they are charging from the proceeds of the loan.

For example, if you sign a note with a hard money lender for $100,000 and you are paying 3 points and 12 percent interest, you will actually receive $97,000 at closing (3 points = the $3,000 taken from the proceeds).  You will usually make a monthly interest payment while the working on the house and until the loan principal amount, which is $100,000, is paid at the time of sale of the property.  The lender will also require the borrower to pay all closing costs related to the loan.  Again, hard money lenders certainly have their place, but of course the numbers have to work for the borrower in order to make the job profitable and the borrowing worth it.

QuickBooks for Real Estate Investing – Rentals

QUICKBOOKS FOR REAL ESTATE INVESTING

QUICKBOOKS FOR RENTAL PROPERTIES

 

In a prior post I covered using QuickBooks for property flipping.  Using the software for flipping is a more straightforward use of QuickBooks and is somewhat easier to explain.  Many software systems have been created to account for rental property, but if you are doing your own bookkeeping and you do not have a very large number of units, it is worth taking a look at QuickBooks and this system.  If you are managing your own property the method I will outline here is a great way to track your buildings, tenants and rents without spending an exorbitant amount of money on an accounting software package.

This is a brief outline of how to use the software for rental property.  I cannot go into extensive detail because it would certainly require much more than a blog post.  If you do decide that this is the method for you after reading this post, there are manuals that have been written that will give you great detail on how to set the system up.  The software is user friendly enough for non-accountants who are willing to put in a little bit of time and effort to learn.  It will allow you to control your real estate investment portfolio and know at any given time where the business stands financially.  There are a variety of useful reports that can be generated in addition to the standard financial reports such as a balance sheet and an income statement (P & L statement).

When setting up your system there is a section to track customers.  For a rental system it is recommended that your buildings are identified as your “customers.”  Within the customer base you can identify individual jobs.  Your tenants become your jobs.  So, your customers (buildings) can have within them multiple jobs (tenants).  So, for example, let’s say you own two apartment buildings.  Each building has three tenants.  Your system would look like this:

Customer:  100 Main St.  (This is building 1)

Jobs:  Apt. 1 Smith

Apt. 2 Jones

Apt. 3 Williams

Customer:  200 Elm St.  (This is building 2)

Jobs:   Apt. 1 Rodney

Apt. 2 Dangerfield

Apt. 3 Quick

 

In my prior writing I discusses the significance of using the QuickBooks class system for flipping properties.  Now I will let you know how it is useful in tracking rental properties.

One way of using the class system for rental properties is to set up each property as a class.  There are other identifiers that can be used within the class system as well, but the basic setup for rental is to identify each building as a class.  There should also be a class for items that may not necessarily be related to a specific building.  Each expense and revenue item you record should be identified with the class that corresponds to the building the revenue or expense is attributable to.  If it is a general expense that is not specific to a building then the class would be a “general” or “office” or some other identification that is to your liking.   When you want to see how each individual building looks financially you would go to your reports and request the balance sheet and Income Statement (P & L) by class.  You will be quite pleased to see that you have tracked the worthiness of each building and now know how each performs independently.

There are probably a few different reference manuals published that explain the system, but I found That “Property Management with QuickBooks” written by Don M. Lander and continued by his daughter, Lisa Edwards was a great reference for this system with great detail.  More information can be obtained at:  http://www.quickbooksforrentals.com/  or    http://www.quickbooks-4-rentals.com/

QuickBooks for Real Estate Investing – Flipping

QUICKBOOKS FOR FLIPS

Although accounting for your business may seem dull to most business people, it is an absolute necessity.  I have found accounting interesting, but of course that is my background.

A versatile piece of software that can keep track of your investing activities is QuickBooks.  I have used QuickBooks for all aspects of real estate investing that I have participated in, this includes flipping houses, accounting for rental properties and also hard money lending.

The way I use QuickBooks for flipping and hard money lending is more straight forward then the way to use it for rental properties. Using QuickBooks for large numbers of building can be cumbersome, but I have used it for some eight to ten buildings and at least thirty units without a problem.  There are software packages specifically designed for tracking rental activities, but if you are an accountant you will recognize the fact that many are not your typical accounting programs, more are designed to keep track of rental properties, tenant activities and rental property owners if you are managing properties for multiple owners.

The way I set up QuickBooks for flipping houses is to put the purchase price and expenses of buying the house on the balance sheet as an asset.  All expenses related to rehabbing the house, holding the house and selling the house are also on the balance sheet as sub-accounts.

I set the address up on the balance sheet and use sub-accounts for the purchase expenses, holding expenses, rehabbing expenses, and selling expenses.  I find that breaking things down further through the use of the QuickBooks class system provides another way of further distinguishing expenses.  For example, the rehab category might include classes such as electrical, plumbing etc.  The holding category might include class items such as utilities, insurance, interest on any loans and so on.  Using class categories rather than using another layer of sub-accounts helps to keep the balance sheet a bit cleaner.

Once the job is complete, and the house is sold, I take the revenue as income identifying that house address as an income account on the Income Statement (P & L) and I move all of the related asset items over to the Income Statement into a cost of goods sold account.  This is a contra-account above the gross profit line under the related income account.  In other words, the account appears directly under the revenue account so it gives me a gross profit on that project.  From the total of all of the gross profits I deduct any other general expenses I have, such as office expenses, telephone, transportation etc. to come up with the net income.  If you have used QuickBooks I hope with some close reading you can follow how I handle accounting for flips.  If you haven’t used QuickBooks you may want to check its usefulness.  In my opinion you do not have to be an accountant to use the software.  I will discuss using QuickBooks for rental properties in the next blog.

First Things First – Business Structure

There are a number of ways to get started in real estate investing which I can cover.  Among them are flipping houses, wholesaling houses, investing in tax sales and tax liens, loaning money to individuals who rehab or to rental property investors, buying and holding property for rent, buying and holding property for lease-option, buying and holding while extending a short-term private mortgage (while helping your buyer fix less than stellar credit so they can eventually refinance with a conventional mortgage).  I am sure I am leaving some things out, and you may not know what each possibility that I have listed means, but I will get into covering these options for investing in future blogs.

When I say first things first, I do not only mean deciding on what type of real estate investing you want to initially pursue, but what structure your business will take and how you will account for the activity of the business.  You should always be aware that you must protect yourself legally as much as possible.  That usually means setting up an LLC (Legally Liable Company) or a corporation or even one or more trusts.  I have established many LLC’s for myself as well as for others without any problem because of my background as a CPA and my experience.   You may feel more comfortable hiring someone to care of this paperwork.  In Connecticut, the LLC is registered with the Secretary of the State for a fee of $120.00.   The LLC is established by submitting to that office a document that is known as Articles of Organization.  The Articles of Organization identify the name of the business, purpose of the business, business location, identifies one or more members or managers and also the individual being appointed for the purpose of receiving any legal notices. Soon after you receive the notice that the Articles of Organization document has been received and accepted, you must obtain a Federal Employer Identification Number through the Internal Revenue Service.  In some states, such as Connecticut, you must obtain a state tax number as well.  The governmental cost of establishing an LLC will vary from state to state.  For example, Connecticut currently charges a filing fee of $120 while Massachusetts charges a filing fee of $500.

A trust is a different kind of structure.  Establishing a trust may take the work of an attorney who specializes in the area, but I would suggest doing some research through a real estate guru.   Lou Brown, a real estate investor who has worked with trusts, is someone who can provide some insight (Street Smart website:  https://streetsmartinvestor.com/).  Doing a little research and having a discussion with a knowledgeable attorney will help you make your decision.   I have personally never used a trust. I have used the LLC structure exclusively, and the bulk of my investments have been through a  real estate IRA, so I have not necessarily needed to be concerned as much with a trust.

Business can be conducted initially under an LLC structure then the property can be moved into a trust.  In addition, an LLC can elect to be taxed as what is known as a Subchapter S Corporation.  Each individual must decide what is best for their situation.   Sometimes you may think you need a crystal ball to make the decision on how to be taxed.  It can be difficult to see into the future. I have also used a stock corporation structure, but that can be cumbersome, unnecessary and possibly not provide you with the best tax advantages.

So, if your idea is to start by flipping, buying and holding or even starting as a wholesaler or lender, I would strongly recommend conducting that business under an LLC rather than your own name or a stock corporation.  However, as always, the choice is yours and depends on your particular situation and the number of people involved in your business venture.  Often in situations where an investor is acquiring property to rent the acquisition is made through an LLC then, when a trust structure is the preference, the is property is moved into a trust.

In addition to being wise about the structure of the business, you must be wise about accounting for your activity.  Don’t wait until you have been in business for six months or a year to decide to keep track of your business activity.  Get set up for keeping track for your income and expenses at the beginning of your venture.  Not only do you need financial information and data to determine where your business stands from a profitability perspective, but you will need the information to provide to partners, investors and your tax accountant.  I have been very successful using QuickBooks for my real estate accounting, and have used it for more than 30 rental units without a problem.  However, there is software available specifically designed for managing rental property that is probably more equipped then QuickBooks in handling large numbers of rental units or for managing rental units for a number of different individual owners or investors.

When you have decided what type of real estate investing you would like to do and have taken the steps identified here, you are ready to get out and start your real estate investing activities.  Good luck and continue reading this blog for more pertinent information.