The hunt for a bargain property

[pyriel]

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I have this little project. To find a bargain property that will provide me positive cash flow throughout the entire lifecycle of the mortgage. My purpose for creating this blog is to teach others on what steps to take to get a cash flowing rental property. I will show the following:

1. How to look for a rental property or flippers

2.How to find aproperty

3. How to conduct a paper analysis for cash on cash return for the investment

3. How to submitan offer/tying up the property

4. How to conduct due diligence

5. How to get financing (I will also talk about what the bank usually look to get a good financing)

6. Closing the property and how to get it rented or sold

I will actually buy a property for this project. Let's go make some money...:^

 

[Show-me]

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Sounds like fun!:^

 

[pyriel]

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1. How to look for a rental property or flippers


Since yesterday, i've looked at more than 100 properties. I went to Multiple Listing Service (MLS) and I also read the newspaper advertising column. I was in luck since Tuesday is the day that real estate advertisementcomes out. I also picked up a couple of local magazines that have real estate advertising.I am pretty well versed with the real estatemarket in my area and I recommend that people who wants to get into real estatedo thisdrill so that they can get a better feel of the market.So far, 3bd 2bt that is around 1100 sf is running about 125-140k in average. This is totally different2-3 years ago when theywere an easy pick for 80-125k. Real estate is definitely going up. I have two properties that I selected and have informedmy real estate agent that I want to see them this Saturday. Here is the breakdown:

1. 3bd 2 bt w/ tenants. Property is located near my other rental properties. Asking price is 128k.

2.4 unit apt with avery big house. 4 unit is divided into 2 = 2 bd 1 bt and 2 = 1 bd 1bt. Place is R2 located in a half acre lot. Place is central andit is within my neighborhood.Asking price is 369k.

Next, i'll be doing the paper analysis to see which one will give me a better return.

 

[Shaggy]

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I can't wait. Thanks for doing this step by step, it should really help!

 

[pyriel]

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I've added two more properties to look at this weekend.

3. $127,500 4bd/3ba 1,357 sf 600sqm, w/huge extension at rear, carport, MOTIVATED SELLER (my favorite friend). place is about 30-45 minutes south from where I live. Most of my properties are north of my place so this is going another direction and could be an inconvenient to pick up rent... I'm lazy...

4. $125k 3bd/1.5ba fully fenced, ceramic tiles, indoor laundry, carport and split a/c. This is about 10 minutes from the rest of my other properties.

My rule of thumb, research 100 properties, pick 10 properties,make an offer on 5, buy 1.Never ever pay the asking price except for extraordinary circumstances like you are in Hawaii and you know that thereis an aircraft carrier thatis about to be assigned there (this is a fact and is currently happening in Hawaii).

I currently have 30k in the bank.This is the left over proceeds from me selling my 4plex that I got for 170k in July and sold it for 250k onOct.I am also in the process of refinancing my 8 unit apt which was bought for 240k in March 2003.Current balance is 198k. I'm looking to refinance for 280k. After everythingsettles, I shouldpocket 65k for that transaction.I also have 50k equity line of credit for the 8 unit apt.This gives me30k + 65k+ 50K = 145k readily available cash to purchase a property.

This power will allow me to buy the property in cash and should give me negotiating leverage with the seller. However,another rule of thumb is that the less money coming from your pocket the higher the return and lower the risk.You can rest assure that I will only use all my cash if I could get a better deal from the dealer. However, as soon as the property is under my name, I will immediately go to the bank and refinance so that I can get my money back. Here is an example, Lets say the sellerwants 125k but there are something wrong with the house such as renovation which would cost about 5k. I'd offer105k-110k, i'd pay all cashwe'd close in1 week. If the property appraised for135k (my real estate agentused to be an appraiser and he always tell me if the property could be appraised higher than the selling price) and the title is mine free and clear, the bankcan lend me 80% of the appraised value which should come out to 108K.If I paid 110k and got back 108k by refinancing, I just lower down my risksince now my cash on cash investment on the property is only 2k.

On top of my head, 108k with 7.5% interest w/30yearsshould give me a mortgage of $600 property tax and insurance should be another$150 for a total of $750. I know that I can rent a 3bd/2 bt for$1100.This would give me $350 positive cash flow per month and$4200per year.Sincemy investment went down to $2k, my cash on cash return on my investment is 210%.This means that I will get all my money backfor the first year(plus more) and every year after thatare all profits.

I hope that you can all seewhat I am talking. I'm open to discuss this for anyone who might have any questions concerning to this post.... Sorry, very lengthy...

 

[Shaggy]

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I have a question. You know about my rental property as we have talked about it before. It is a trailer on an acre. I bought it and paid for it in five years why I lived there. Now it is a rental. Can I still depreciate it now that it is an investment? Is so at what rate? I thought from my accounting classes many years ago it was a 10 year depreciation, but I cannot seem to get the calculation you used on the example spreadsheet you provided.

 

[pyriel]

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Shaggy wrote:

I have a question. You know about my rental property as we have talked about it before. It is a trailer on an acre. I bought it and paid for it in five years why I lived there. Now it is a rental. Can I still depreciate it now that it is an investment? Is so at what rate? I thought from my accounting classes many years ago it was a 10 year depreciation, but I cannot seem to get the calculation you used on the example spreadsheet you provided.

Hmmm... The rules don't changed just because you paid off the property and made thema rental. Something about depreciation, it is constant. This means that if you use 40 years as your depreciation factor when you first bought it, it should still be the same one youshould use while you are having it rented.However, please don't think that you can start all over again since the property is now a rental property. So your depreciation factor should beCost of purchase divided 40 years.Totalfor each year is your depreciation factor.

Please note that my expertiseare buildings, houses, and apartments. I am not very familiarwithtrailers (Our typhoons will toss them in the air in a heartbeat). 40 years is a safe depreciation factor for it covers pretty much all of them. However, it might not be conducive for you especially if you are trying to depreciate your property faster. In some of them you can use 27 years as depreciating factor.:^

 

[Shaggy]

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OK but I have never depreciated it any because for the first five years I lived in it so I could not take a depreciation on it. So I would have to take the purchase price / by say 30 years and then apply that amount for the next 25 years since I was not entitled to the first five. Sound right?

 

[pyriel]

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Shaggy wrote:

OK but I have never depreciated it any because for the first five years I lived in it so I could not take a depreciation on it. So I would have to take the purchase price / by say 30 years and then apply that amount for the next 25 years since I was not entitled to the first five. Sound right?

You are entitled on the first five. Depreciation is not just for rentals. It is also for homeowners...:^

 

[pyriel]

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As of Saturday, 8 Oct 05, I visited all properties that I picked. I was going to do the paper cost analysis but decided to wait until after I saw the properties. Out of the 4 properties I looked at, I've decided thatonly onefits my investment rules; #1. (3bd 2 bt w/ tenants. Property is located near my other rental properties. Asking price is 128k).

#2 was eliminated because although it is a good investment, the I would have had to put 30% down payment. Askign price is 369K. Even if I am successful in bringing it down to 300k, I still have to come up with 90k for downpayment + closing fee and appraisal of about 20K. Loan will have to go to commercial because all banks here consider anything above 4 units to be in commercial loans. There is also an issue whether there is a setback problem due to close proximity of the 4 plex and the big house upfront.

#3 was eliminated because I learned that although the owner is a motivated seller and she is currently off island, she is not hurting financially. Place will also be harder to rent since it is farther away from the city. There is also an estimate of 10-15k of repair that must be done.

#4 was eliminated because I learned that the owner bought the property for 115k a year ago. He went ahead and put a fence around the properties because of his dogs. I feel that the owner will not have any room to negotiate since he is still maxed out with his loan + fencing costs. Place is also located in a ghetto like area so appreciation is unlikely. I like buying a property in a steal with equities imbedded into it.

What is a setback? Setback is the boundary betweent the building and the property point. Here A house must have boundary points of 10 feet in the back, 8 feet on the side, and 15 feet in front. If the house is non conforming, it gets harder to get a financing from the bank. Now it is not impossible to get financing somewhere else but you will have to sacrifice loan term such as ARM instead of fixed, prepayment penalties vs. no prepayment penalties, etc. etc...

I will be going back toproperty #1 this afternoon to relook at the inside of the house. If I like what I see, I will then do a paper analysis for my cash on cash return on investment. If I don't like what I see, I am back to square one and must resume looking for another 100 properties. Happy rental house hunting...

 

[Quips]

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I currently have 30k in the bank.This is the left over proceeds from me selling my 4plex that I got for 170k in July and sold it for 250k onOct.I am also in the process of refinancing my 8 unit apt which was bought for 240k in March 2003.Current balance is 198k. I'm looking to refinance for 280k. After everythingsettles, I shouldpocket 65k for that transaction.I also have 50k equity line of credit for the 8 unit apt.This gives me30k + 65k+ 50K = 145k readily available cash to purchase a property.



Okay, I hear you. Like many people with much experience in a particular field, they tend to take much of their knowledge for granted especially as it concerns how other(s) would understand what they are saying.

The first two sentences tell me that80K was madein three months, over 50 % or 200% return in one year. Nice return: Question: howdid that happen? How does one get such a huge return in so little time?

Anyhow, there was 30K left over from that transaction.Now the next two sentences; an 8 unit apt was bought in Mar. 2003 for 240K, and currently 198K is on the mortgage. I suppose the rental income is being used to pay the mortgage there. By refinancing for 280k, does that mean the property has appreciated 40K over that timeframe? The 50K equity line probably includes the rental income and how that was used to secure equitysince March 2003.

After everything settles, I should pocket 65K for that transaction. It is plain where the first 30K came from, it is not so obvious where the 50k came from, but I gather it came from the rental income.

By refinancing at 280k, the price appreciated after 2.5 years; okay, are you saying then that 40k difference is being counted as increased equity on your property so where does the other 25K come from to make 65K?

Sounds complex.

 

[pyriel]

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Quips wrote:

The first two sentences tell me that80K was madein three months, over 50 % or 200% return in one year. Nice return: Question: howdid that happen? How does one get such a huge return in so little time? Actually, the return is much higher than 200%. I used my VA loan to acquire the 4plex (so no money down) for 160k. I included some of the closing cost and VA also let me borrow 6k more to install energy efficient appliances. So my mortgage went up to 170k. The place needed some renovation so I went to another bank and borrowed 25k to pay for some closing and renovation. As you can see, no money has left my pocket yet. Iclosed on the property on7 Jul 05. I thensold it for 250k. So lets do the math. 250k (selling price) - 170k (loan amount)= 80k - 25k (personal loan from another bank) = 55k - 13k (truck loan from the corporation) = 42k - 12k (I decided to renovate some part of my house = 30k. However, the real profit is 55k or 55,000% within 3 months and not the 200% that you mentioned earlier. Why is it 55,000% and not 200%? This is because I have zero money that came out of my own pocket. All investment within this deal came from OPM. So for zero money investment, I received 55k in return.

Anyhow, there was 30K left over from that transaction.Now the next two sentences; an 8 unit apt was bought in Mar. 2003 for 240K, and currently 198K is on the mortgage. I suppose the rental income is being used to pay the mortgage there. By refinancing for 280k, does that mean the property has appreciated 40K over that timeframe? The 50K equity line probably includes the rental income and how that was used to secure equitysince March 2003. 8 plex was bought for 240k. I put a 10% down and the bank financed 216k. Tenants have been paying for 2 years now and my balance is 198k. So my cash investment that came out of my pocket is 24k + 8 k closing cost = 32k. Property was bought in dilapitated state (this is what I like buying run down places). The property, we believe, is now worth over 400k with no less than 350k. So worst case scenario, the property appreciated 110k within 2 years or best case of 160k (or more?). (I'll talk about how appraisersdo their figures toward the end). As for the 50k equity line of credit that I have with the property, I pay $300 to keep that. They give me checks that I can tap into whenever I feel like doing so. Right now it is just sitting there just in case there is a really good deal that pops out. The $300 yearly fee is tax deductible.

After everything settles, I should pocket 65K for that transaction. It is plain where the first 30K came from, it is not so obvious where the 50k came from, but I gather it came from the rental income. 50k is an equity line of credit usable anytime I feel like it. here is the breakdown for refinancing the 8 plex. Refinanced for 280k - 198k (loan amount) = 82k - 8k (prepayment penalty) = 74k - 9k (closing cost and appraisal fee) = 65k. There is your 65k.Now people always tell me that real estate is risky. But lets look at this particular scenario. I put down 24k + 8k for closing for a total of 32k. This is my cash investemnt for this property. After doing my refinance, I will get an excess of 65k. This means that I will get all my money back within 2.5 years. That is a return on my cash on cash investment of over 200% return. You see? Not only that I got my cash investment back, Iactually doubled them and the money is here right now, ready to be used. Unlike our TSP, IRA, 401k, you have to wait until you retire totouch them. I also was able to utilize the phantom incometo bring down my personal income tremendously. The best part of all of this is thatallpassive income coming from the rental now are all profits or return on investment. My original investment is back in my pocket. Now, i'd like anyone to tell mewhich one is more risky, our TSP, IRA, 401K or real estate investment.

By refinancing at 280k, the price appreciated after 2.5 years; okay, are you saying then that 40k difference is being counted as increased equity on your property so where does the other 25K come from to make 65K?Please read above. I showed you where the 65k came from, where the 30k came from (it is actually 55k but I used some of the money which left me with only 30k), and where the 50k came from (equity line of credit).

Sounds complex. It is not that complex.

 

[pyriel]

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I inspected the place last Sunday and the structure of the house seems sound. The side and the back seems to be to close for comfort to the boundaries and the real estate agent said that she will check on it. My plan is to close off the carport and convert the house from 3 bedroom to 4 bedroom. Why? Section 8 pays $1400 for 4 bedroom vs. $1150 for 3 bedroom. This is a $250 jump per month and $3k per year. Cost to convert carport to extra bedroom is about $3k.

My real estate agent and I agreed that the house is probably worth $110k - $115k. Selling price is $128k. We will be making an offer for $105k and will work our way up once negotiation starts. If our offer is accepted, we just tied up the property. Some people thinks that due diligence is the next step because they want to know more about the property. Wrong! Tie up the property by making an offer but also ensure that you have a way out if you don't like what you find with your due diligence later.

Now, how do you get out of the contract between seller and buyer? In your offer, you must put down "contingencies." contingencies put the seller on notice that you will be looking carefully at specific items pertaining to the agreement and that your final decision to buy is based on those findings. Here are some example of contingencies: 1. Review and acceptance of all financial records, 2. obtaining clear title to the property, 3. Satisfactory inspection of the property, 4.Securig financing acceptable to the buyer 5. Partner's approval 6. This offer is subject to .... You can add more to it if you like but the concept is to put contingencies for you to get out if you don't like what you find with your due diligence.

When I make an offer, I always put in the following"My name and/or assigns, Subject to satisfactory inspection of the property, Subject to buyer securing financing acceptable to the buyer andSubject to partner's approval."

 

[pyriel]

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I added two more properties to look at. I have two prospective section 8 tenants that would like to move in. One requires a 3 bd while the other requires a 4-5 bd. Section 8 pays $1200 for a 3 bd and $1500-$1600 for a 4-5 bd.

5. 3bd/2bt $104k near the rest of my properties.

6. 3bd/2bt bank foreclosed and selling for $90k.

I've decided to buy two properties before the end of this year instead of one that I mentioned earlier. The problem that I am foreseeing here is the price and quality of the properties I am researching and the cash on cash return on my investment. Everything is going up now and it is getting harder to find real bargains. I still need to do the paper analysis and will put that out sometime today. Good luck to all...

 

[pyriel]

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Attached is the paper analysis for cash on cash return on investment if I decide to buy the house #1.The premise here is that I will put 20% down, make an improvement of 10k and rent it out for $1400 per month. For those of you who are following me, please take a look at the attachments and I want you to pay particular attention to the down payment. Try playing around the down payment and repair and see how it changes your cash on cash return. Bottom line, the lower the cash coming out of your pocket, the better the return. So, if you can do the work yourself for maintenance and/or you can get a better financing with lower down payment, do it.

A VA loan with zero down payment (only closing cost) would have provided me with abouttwice the return and get all my money back in less than two years. The cash on cash analysis below will take me 5 years to get my money back with 20% yearly return on my cash investment. Please don't forget that I am not even including phantom income such as depreciation, interest payment and property tax.

Now, usually, I look for properties that will give me a much higher return. However, at this point of time,I don't have a choice. I have from now until December 31 tocreate deduction for the profitthat I received from the 4 unit apartment I sold recently. So far,I've already managed to create a 44k deduction fromthe 55k profit that I made. Butmaybe, i'd talk about that in a different thread. I promisedmyself not to let Uncle Sam touch a penny of that 55k profit. hehehehe

 

[pyriel]

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I made two more offers for 2 different house.

House #5. I offered 83k with 10% down and the seller waives points and closing cost. They should also finance the other 90% without a prepayment penalty.

House #6. I offered 70k all cash to close within 20 days upon acceptance of the offer.

Total offered on the table = 3 houses. How the hell am I going to buy all these? I don't know... Main point is to tie up the property so that I am not competing with anyone.

With house #6, I promised to help a friend. He also put in an offer for 75k, 100% financing to close within 60 days. We think that his offer is weak and the house is already sold pending without any paperwork (at this time). Renovation $ will be about 15k-20k. My real estate agent advised me that he can easily sell the property for 125k. He knows that I do good work with my renovation (I mean my workers). If I get it, I will just resell it to him at cost + closing cost and interest from my other financial backers. Bottom line, I will not make money out of this. Too bad, it would have been a good 30-35k profit within 3-4 months. But that is ok... I am teaching him how he can make real estate works for him...

More to follow...:^

 

[clester]

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Pyriel,I sent you a PM. I have a rather lengthy question.Thanks

 

[pyriel]

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Clester, I wish you luck.

I've spoken with someone who I know have available cash. I informed him that I would like to take his 50k. In return, I will give him 1% per month until I repay him the whole balance of the loan. He will write the contract so that he knows that our agreement will be in his favor. I also told him that the contract should add that I become responsible for all attorneys fees if he ever decides to take me to court. I also told him to adda clause thatif I don't pay my 1% monthly payment on time in two consecutive months that I he can take me to court for defaulting on the loan and I would have to incur an additional 10%of the debt. I am willing to go to 2% per month but I am not about to tell him that.

Now, this could be risky for others but not for me. The reason for this is because of advance real estate which is what I am about to discuss. Let's say that for house #6 they take my offer for 70k all cash payout. I will take his 50k + my 20k = 70k. I now freed up some of my cash for renovation. I will renovate the place within a month and then go to the bank to make a loan using the newly renovated house as collateral. So let's say that it took two months to do all that and I am able to get 80% financing for my renovated property. My real estate agent and I know that a good renovated house within the area can appraise for 135k. 80% of 135k is 108k. My cost to borrow his 50k is 1k for two months. Profit? 108k - 50k = 58k - 1k = 57k - 40k (20k my own money and 20k renovation) = 17k.

I can rent the house for $1100. Since the borrowed money is 80% of appraisal, I don't have to pay for PMI. Just take the cash on cash analysis excel worksheet and plug in the numbers and you will see that there is a positive cash flow for this deal. Notwithstanding the fact that I now have 17k to further help my renovation...

Hope this helps you all figure out ways to come up with ways to make real estate work for you... Next topic will be financial statement as your report card to the bank...

BTW, got another place to live while my cotractors renovate the house. Thank goodness...

 

[pyriel]

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I'm attaching a copy of a financial statement that you can use for you to manage your wealth. This is also a good tool to provide to the bank just before you ask them to prequalify for a loan. What I usually do is call all the banks to see who has the best rate. Please don't be fool with just looking at the interest rate. You must also look at closing cost, appraisal cost, points etc. etc. Remember, and I believe i've shown this in my previous post that the LESS MONEY COMING OUT OF YOUR POCKET, THE HIGHER THE RETURN. That is the bottom line. Once I find out who has the best rate, I usually give them a call and explain to them the property that I wanted to purchase. I then email them my financial statement so that they can see a snapshot of my expenses vs. my income and my liability vs. my asset. One thing i've found out is that 90% of the loan officer that i've communicated with also does not know how to look at financial statement. I've always had to explain to them what they are looking at.

I do my financial statement monthly. The reason why I do this is so I can see which EXPENSE I should try to pay off first. This is important. If you have 3 credit cards balances and you try to pay extra for all of them, it will take a long time to pay them off. Always pay off the minimum to the card that has the lowest interest rate. Pay all the extra money you have to the one with high interest rate. Once you are done paying off one card, go ahead and send all your extra payment to the next card. As of today, I have no credit card expenses (i pay them off in full monthly), I have no car expenses (they are all fully paid), andI have real estate payment but they are being offset by rental income.

The bank doesn't care if your suma cum laude in college. This financial statement is your report card. They will look at your income to expense ratio and if you do not meet that standard, they can either deny you loan or give you loan that is conducive to their term... They are looking at assets that provide income that will offset the expenses. Your asset column should be higher than your liability column. If you find that your liability column is higher than your asset, it means that you fall under the category of middle class financial statement which I will talk about on my next post.

 

[pyriel]

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Negotiation for House #1 and #5 fell apart.

For house#1, seller decided not to do a counter offer. If you all can recall asking price is 128k and I offered 105k. They came back with 122k and i countered with 108k.

For house #5, bank foreclosed and selling for 103k. I offered 83k, 10% down and they finance the rest. They countered with 103k.

I informed my real estate agent to wait another 30 days and given them my last offer again. He is to do that until the properties are sold or they decide to consider my offer. The only other offer I have that is in the table is House #6. I offered 70k all cash. Property is foreclosed and owned by Fanie Mae. Something about Fannie Mae and Freddy Mac, these two behemoths are slow movers. It could take weeks or months before I get an answer from them. So far, our offers has received no response for two weeks now... We'll see.

Pice of advice. Do not ever buy a rental property to meet seller's price unless you've done your numbers crunching. Although I could have met sellers' offers for both properties, I decided not to do it. One, I am looking for a bargain and I am willing to wait. Two, it would have eaten some of the profits or cash on cash return on my investments. Three, my recourse to dump the properties would have been less than satisfactory because I would have been buying them high. Always remember that there will always be another deal waiting. Good luck..