Real Estate Investing Archives - Preferred Residential

How to Limit the Risk of Investing in Real Estate

“No risk, no reward.” That phrase has been applied to everything from play calling in sports to starting a business to investing in real estate. It suggests that if risk is not taken then there will be no reward. That may be true but it does not mean that we have to sit back and accept the risk. When it comes to investing in real estate there are things that can be done to limit exposure to risk and thereby improve chances for an even better reward.

Limit the risk from tenants. Where the property is located and what condition it is in will affect what kind of tenants will be interested in living there. Buy a house that is in a thriving neighborhood, in a good school district and doesn’t look like it has had a hard life for the last 20 years. Before renting to tenants run a credit and background check on them, remembering of course, what the law says about what can and can’t be considered when accepting or denying a tenant. Collect deposits and rent in cash or verifiable funds before allowing them to move in. Letting a tenant move in without the necessary funds can be worse than leaving the house vacant.

Limit the risk that it will require too much of your time. The more time you spend dealing with tenants or making repairs the less time you will have to make money whether it is finding the next real estate deal or keeping your boss happy at work. Hiring a good property manager means someone else will be there to answer tenant phone calls, collect rent, schedule repairs and check on your property.

Limit the risk of costly repairs. Find out as much about the property as possible so that you don’t end up buying something that will drain all of your resources. Buy a home that is less than 50 years old as they are less likely to have structural problems that could cost tens of thousands of dollars to fix. Get a professional inspection of the property before the purchase is final and if there are any questions about any of the systems, such as the furnace, hire a specialist to inspect that. If the problems are more than you are willing to deal with then move on to the next property.

Limit the risk that the property won’t support itself . Research other rentals similar to the rental being purchased to know what the property will realistically rent for. Run the numbers then run them again. If the property won’t at least break even then you should probably keep looking for one that will.

Limit the risk of long vacancies. Buy investment properties in parts of town where people want to live, keep the property in good condition and start advertising as soon as you know the tenants will be moving out.

Limit the risk of losing value. Keep an eye on your investment. Despite all the things they told you about how well they are going to care for your home, your tenants don’t have as much at stake as you do. Drive by the property frequently and inspect the interior of the home at least annually. Protect yourself from real estate market down turn by buying a property for less than market value.

Limit the risk of not being able to sell the property. Real estate is not a liquid investment which means you shouldn’t expect to be able to sell your rental property at the drop of a hat. However, there are some things that can be done to help it sell as quickly as possible. Buying a house in a good neighborhood, close to employment opportunities, in a good school district. The real goal is to buy a house that when it comes time to sell will appeal to the most potential buyers. Not just investors.

Limit the risk of hiring a bad property manager. This also applies to you, the investor/owner as property manager. For those investors wanting to manage their own properties here are some great questions to ask yourself. Should I hire a property manager? If actively managing your rental isn’t for you then here are 8 tips for hiring the best property manager.

Should I Sell Or Rent My Home?

Your current home is the first home you ever purchased but you are ready to move up to something a little more “comfortable” and now you wonder, “Should I sell my home or rent it?” Here are some things to consider when searching for an answer to this question.

Would the listing description for your house be accurate if it said, “Good bones with shag carpet and olive green appliances?” A house that is still stuck in the ’70’s isn’t going to command top dollar in any real estate market. Buyers will likely see the decor and wonder, “If the decor hasn’t been touched in decades what else in the house has been neglected?” Tenants on the other hand can be willing to overlook questionable decor for a good house at a good price. If you don’t have money or desire to invest in new fixtures that are outdated but work perfectly fine then converting your home to a rental might be the way to go.

What are they doing to my home? Tenants won’t feel the same way about your house as you do. Flooring will get stained or scratched, walls will get nicked and dirty, and landscaping will show signs of neglect. If seeing your former home in less than pristine condition is going to cause angst and restless nights then you might be better off selling your home.

They say money isn’t everything. That may be so but when it comes to buying a new home and converting the old one to a rental, money is very important. You will need cash for a down payment on your new home, income (rental and wages) to make two mortgage payments and reserves to cover repairs and improvements for both homes.

The first step in the money equation is to talk to a Realtor® and figure out how much the house you want to buy is going to cost and how much equity you have in the house you already own. This will help you determine how much cash you will need to buy a new home and if some of that cash could come from your current home.

Once the value of your current home has been determined it is time to figure out how much it might rent for. If your Realtor® also happens to own a property management company (Becky Seim, Preferred Residential) then putting a dollar amount on rent will be no problem. Without that resource your best bet is to browse the local property management company websites, classifieds or Craig’s List for similar properties near yours.

Armed with all these numbers you are now ready to talk to your mortgage lender. If the numbers the lender gives back to you suggest that keeping your current home as a rental is going to prevent you from qualifying for a loan for a new home then selling your current home is probably a wise move.

Taxes are money too. You have enough money to afford two mortgage payments and a down payment on a new house but do you know how owning a rental affects your tax bill? Talk to your tax preparer. Know the benefits and drawbacks of converting a home to a rental. will you be able to reduce your taxes or will the positive cash flow from your rental push you into a new tax bracket? What will happen when it comes time to sell the rental? If the tax implications of owning a rental meet with your approval then it is likely a good idea to convert your home to a rental.

Have a plan for property management. You made it this far. Now is NOT the time to think the rental will take care of itself. It won’t. If you plan on managing the property yourself, take the time to honestly answer these questions: Do you have enough time? Do you understand or are you willing to learn local landlord/tenant laws? Are you tough enough to evict a tenant who isn’t paying rent? Even if the tenant really, honest to God, pinky swear, promises to pay next month? Did you Google “what you need to know about becoming a landlord“ and read stories about both the good and bad of being a landlord?

Tight Rental Market in Bend, Oregon Leads to Rising Rents and Few Vacancies

Over the last three years the Bend rental market has shifted dramatically from one with an ample supply of rentals and moderate demand to one with a shrinking supply of rental units and a growing demand for those units. Over that time the vacancy rate in Bend went from a reasonable 5.17% to an unbelievable .66% (yes, two thirds of one percent). *

Things really got rolling in 2012 when the economy in Bend started showing signs of life again. So much of the economy here depends on tourism that when people began travelling more and visiting Central Oregon we saw the unemployment rate start to drop noticeably. That up-tick in jobs and an incredibly low mortgage interest rate gave builders some confidence to start finishing developments that had laid dormant since the real estate bubble burst in 2008. Those builders, of course, needed framers, roofers, masons and carpenters who provided even more spark to the local economy.

That spark led even more people to consider moving to Bend. We haven’t seen any official numbers but it seems as if the number of people moving here is the highest it has been since 2005. Preferred Residential just advertised a home for rent and half of the phone calls and emails we received were from people who are moving here or have already moved here but haven’t been able to find a rental. What is interesting about the people moving here is that they aren’t just from the Northwest. We had prospective tenants call from as far away as Tennessee and Georgia. The large number of people moving to Bend is placing a lot of stress on the shrinking inventory of rental homes.

The number of rental units in Bend is shrinking because many owners are selling their homes to take advantage of rising home prices. Last year we suggested that profit taking could be a factor in 2014 and based on our interactions with prospective tenants it sounds like that is happening in spades. We haven’t kept formal records but if I had to bet, I would say probably two thirds of the people we have talked to about rentals this year are looking for a place because their current rental sold. Another indicator of profit taking by investors can be found in showing instructions for homes for sale. Especially for homes under $300,000.

When prospective tenants call us it is easy to differentiate between people who have just started looking and those who have been looking for a long time. Those who have just started looking have no sense of urgency, don’t have any idea of what is on their credit report and ask for showings that fit their schedules. The conversation with those who have been looking for a long time usually goes something like this: “Is the house still available? Good, where do I apply? Just so you know, I have X and Y on my credit report and my income is 2.3 times the monthly rent. Will that be a problem? No, I don’t need to see the house. I can tell that I like it from the pictures.”

Many renters are getting desperate and who can blame them? It is not unusual to meet people who have been searching for a home for months. Many tell us they feel that finding a rental almost has to become their full time job and they keep missing out on houses because they actually do have a full time job. It has even gotten to the point where there is now a group on Facebook called Bend Housing and Rental Relief Support Group.

*Vacancy rates and rent prices are based on the annual surveys of members of the Central Oregon Rental Owners Association.

HOA's and Rental Properties, What Investors Should Know

Often real estate investors get caught up in whether or not a house being purchased as a rental will make money. How much will it rent for? What are the expenses associated with this property? Necessary repairs will cost how much? While Home Owners Association (HOA) dues may be factored into the expense side of the equation it can be easy to overlook the fine print of the Covenants, Conditions and Restrictions (CC&R’s) recorded by the HOA.

Failure to review and understand the CC&R’s of a home owners association could prove costly for a rental owner. The first thing to look for is whether or not the HOA allows rentals. Many do not while some, like the neighborhood in the photo only allow a certain percentage of homes to be rentals.

When the housing bubble burst a number of HOA’s here in Bend, Oregon softened their stance against rentals and turned a blind eye to owners who rented out their houses or condos. Now that the housing market is getting back on solid ground, those once lenient HOA’s are beginning to crack down. Even if there are rentals in a neighborhood with restrictions against rentals, investors would be wise not to purchase a home there. All it takes is for one owner to put up a fight and turn a cash flowing rental into an unoccupied money pit.

Whether or not a house can be rented is not the only thing real estate investors should be concerned about from HOA’s. Home owners associations can restrict most anything that residents can see, hear or smell. Such rules can limit exterior paint colors, dictate when garbage cans can be at the curb, prevent owners from parking their commercial vehicles in plain sight, and even not allow clothes to be hung outside to dry.

Rules like these can be tough enough for a resident owner to follow but a tenant will likely consider them a burden. Especially if they weren’t made aware of the rules when the lease was signed. If tenants decide they don’t want to follow the rules of the HOA, the owner will be responsible for correcting any violations and paying any fines because home owners associations do not have direct authority over tenants.

Investors should be mindful that the more restrictive the rules of a HOA are, the more time will likely be spent answering letters and phone calls from the HOA. Then there is the time spent reminding tenants to follow the rules and/or trying to collect any fines.

When it comes to HOA’s and rental properties, real estate investors should:

Know what the HOA Covenants, Conditions and Restrictions say before making an offer to purchase.
Consider how restrictive those rules are and how likely a tenant will be to accept and follow them.
Make sure tenants get a copy of all of the HOA polices and rules and that they understand they are responsible for following them.

Cash on Cash Return and Why it is Important to Real Estate Investors

One popular metric for measuring the performance (present or future) of a real estate investment is Cash on Cash return. Cash on Cash Return gives an investor a rate of return on the amount of cash invested in a given property. While this is not a perfect measure of return on investment it is a good way to compare the potential return between two given investments or properties.

Cash flow is another popular measure of performance and it is the factor most investors start with when considering a property for purchase. It is also a factor in the Cash on Cash Return equation. Cash flow does not just refer to rents received* but the amount remaining after expenses are paid. Those expenses may include: mortgage payments, utilities paid by the owner, repairs, insurance, property taxes, home owners association dues, landscaping and property management. It is important to remember that each property is unique and investors would be wise to do their homework to determine not only what the property is likely to rent for but also what expenses will be incurred.

The next factor in the equation is how much cash out of pocket is invested. Each investor has their own threshold for how much cash they can or are willing to invest in any given property. We have some investors who don’t feel comfortable with anything less than 100 percent of the purchase price coming from cash while others are perfectly happy with the minimum down payment required by their lender. Either way is fine but the amount of cash invested will affect the rate of return as illustrated below.

Now we are ready to find out what the cash on cash rate of return is. The equation used is: Cash on Cash return = annual cash flow (income-expenses) / total cash invested.

Let’s use an example of a three bedroom house with a purchase price of $175,000. We could reasonably expect that house to rent for $1295/month resulting in annual rent income of $15,540. In this case our investor will finance 75 percent of the purchase price and make a cash down payment of $43,750. If the mortgage payment (principal, interest, taxes and insurance) comes to $882.99** and other expenses come to $175.00/mo. then cash flow will be $237.00/month or $2844.00 annually. That may not seem like much but it works out to 6.5% Cash on Cash Return. Now lets assume all other factors are the same but with an all cash purchase. Under this scenario cash flow would be $1120.00/month ($1295-$175) and Cash on Cash Return would be 7.7%.

Cash on Cash Return is a great tool to use when evaluating a real estate investment but it is important to keep it in perspective and remember that it is a snap shot of one year. It does not take into account the time value of money or gain/loss when the property is sold.

* If you will be borrowing money to purchase an investment property, your lender will use 75% of expected income but 100% of expected expenses for qualifying purposes. In the Bend, Oregon rental market right now investors can essentially expect 99% of income for planning purposes. In most cases, the property management side of our company is able to minimize vacancies to about one week between tenants unless the unit requires extra cleaning or repairs.

** Assumes interest rate of 4.75% based on today’s rates, property taxes of $2200 annually and insurance of $35/month.

Investor Friendly Realtors: How to Find Them

Real estate investors are a different breed of home buyer and as such they need a different breed of Realtor®. There are many factors that go into the purchase of an investment property that the buyer of a primary residence and her agent wouldn’t even think of considering. For example, someone buying a home for themselves might be interested in a big kitchen with granite counter tops, cherry hard wood floors and his and her’s walk-in closets while an investor is going to be looking at cash flow, repairs needed and cash flow.

Those are some pretty big differences in motivation. The problem for real estate investors is that real estate agents who understand the former are a dime a dozen. Those who understand the latter are much more difficult to find, yet they can be found. Investors just need to dig a little deeper to find the right match.

I need (want) to make money from day one: Most any Realtor® understands the financial motivations for buying a home that will be occupied by the owner: “Not paying rent to a landlord and I just love the kitchen!” Far fewer real estate agents understand the financial considerations necessary to evaluate a potential investment property: Is the purchase price at, above or below market value? How much will the property rent for? When it is time to sell the house will this house appeal to owner occupants or just investors?

No spam, please!: No one wants to have a new listing hit their inbox every 15 minutes only to find a house that doesn’t meet ANY stated criteria for a rental property. Being able to tell the difference between a great rental and a bad one is an art form that few agents master.

If at first you don’t succeed, try, try again: It is not uncommon for investors to make offers on multiple properties before one of them is accepted. It’s all about the deal and if the first deal doesn’t come together with the right numbers then you move on to the next deal. Investors should be looking for a Realtor® who understands this and isn’t afraid of or annoyed by writing multiple offers.

Plays well (experience) with others: Not just experience but success with other investors. A little homework goes a long way and investors should ask to speak with clients of the real estate agent being considered. Serious real estate investors should be looking for an agent whose investor clients keep coming back for more.

Um, yeah, my sister lives there: Wrong answer. Real estate investors need someone connected to the market in question. Not someone who vacations there, not someone with relatives there but someone who eats, drinks and breathes the market being considered. Would it be wise to let an orthopedic surgeon operate on your lower intestine? No. Nor is it wise to take advice from someone who doesn’t understand the local rental market inside and out.

Thanks for the deal, good luck with that rental!: Buying an investment property is just the beginning. How do you find good tenants? Sure you can find a lease online to copy and use but do you know if it will hold up in court? What happens when the water heater breaks? Look for an agent who is able and willing to help with issues like these even after the purchase has closed.

For real estate investors, a little homework and asking the right questions can go a long way toward finding an agent who can be an asset to making money on investment properties.

Real Estate Investing: Is Location Important?

Location, location, location! That familiar real estate phrase referring to the three most important factors in real estate. We have all heard it and many of us have even repeated it but it often doesn’t get the consideration it should from real estate investors. Getting the best possible deal has consumed many rental buyers leaving location as an afterthought. What these buyers are missing is that location will play a bigger role in whether or not they make money over the life of their rental property than how good of a deal it was when they bought it. When buying a rental property don’t put location on the back burner, make it a priority using the factors below to help determine if a location is good or bad.

Located in a safe neighborhood: You would think that in a town the size of Bend there wouldn’t be any neighborhoods to worry about but there are. While no neighborhood is immune to crime the question should be, will tenants feel safe living here, walking down the street after dark, and allowing their children to play in the yard?

Near good schools: In Bend there isn’t a whole lot of difference in the quality of education from one school to the next. However, everyone has an opinion about schools so a wise real estate investor will consult a Realtor to find out what schools are most sought after by people moving to the area. K-12 schools aren’t the only schools that are worthy of consideration when choosing a rental property location in Bend. Central Oregon Community College and OSU Cascades are both growing and with that growth comes students who will need a place to rent.

Close to popular places and shopping: By shopping, I don’t mean shopping for shoes or cars. What is the one thing that everyone buys on a regular basis? Food. Whether it is groceries or a meal at a restaurant, people need food and being close to a grocery store and/or good places to eat is a convenience many tenants look for in a rental. Many tenants also want to be close to popular places like The Old Mill or Downtown where so many festivals and concerts take place.

Easy access to throughways and public transportation: Public transportation isn’t as big a factor in Bend as it is in other cities but there are a lot of bicyclists and people who don’t want to spend a whole lot of time weaving through surface streets to get where they want to go. There are a few major throughways in Bend with Highway 97 being the major north/south route. A house with easy access to Highway 97 will be attractive to the most people. This doesn’t mean it has to be a block away from an on-ramp but tenants shouldn’t have to navigate a maze of streets to reach the highway.

Has views or offers recreation opportunities: One of the reasons people move to Bend is because of the great outdoors. Bend Parks and Recreation maintains 28 walking and biking trails throughout Bend such as the Larkspur Trail, Deschutes River Trail, various canal trails and even Pilot Butte. Rentals near parks or with views of the Cascade Mountains or Deschutes River are also very attractive to renters.

Buying a rental property in a location that provides tenants with something more than a roof over their heads will go a long way toward minimizing vacancies, maximizing rent and making the most of appreciation when it comes time to sell.

Tips for Buying a Great Rental Property

Finding a great rental property to buy isn’t molecular biology but it shouldn’t be taken lightly either. There are a lot of factors that can come together to create a snowball effect that determines whether or not you make money on your investment. Here are a few tips to keep that snowball from running you over and emptying your wallet.

There is a saying in real estate circles that goes: “You don’t make money when you sell a home, you make money when you buy it.” Since it is unlikely that you will find yourself owning a rental property without first buying it, this is a great mantra to adopt.

Buy below market value. This sounds easy but it usually isn’t. The days of having bunches of bank owned homes to choose from are gone and that means buyers need to be patient, well connected and probably willing to get their hands dirty. Patience is a virtue that will come in handy not only while you wait for a good deal to hit the market but also when you have trouble making a deal come together. Not every seller is going to be interested in taking a price below market value so some deals are just not going to come together. This also underscores the importance of having a Realtor® on your team who is skilled at negotiations.

Buy in a desirable location. While you are being patient use that time to check out neighborhoods that you might have overlooked. Look for a rental property in a location that offers advantages over other locations such as being close to grocery stores and restaurants, a fantastic school district, a short distance from a park or has easy access to public transportation.

Purposefully buying a rental property in a desirable location doesn’t just improve the odds that it will rent quickly. It also improves the odds that it will stay rented. Appreciation will be much more likely while you own it AND a house in a great location will be easier to sell.

Buy a well built house. Some times saving a few thousand dollars on the purchase price isn’t worth the pain and suffering that could come later with a poorly built house. Find out who built the house you want to make an offer on. If the seller doesn’t know, you should be able to find it in county records on a site like Deschutes County DIAL. Do you already have an opinion about the builder? If not, your real estate agent probably does or at least knows someone who does. If the builder passes the sniff test then put the house through the wringer and get a professional home inspection. Don’t be cheap here, because there is too much money at stake to not know up front what issues the house might have.

There is no such thing as a “sure thing” in real estate but if you follow these tips then you can say: 1) you bought at a discount which means you made money on the house the day it became yours. 2) You bought in a desirable location which makes it more likely the value of the property will go up between the time you bought it and the time you sell it. And 3) You bought a home that was well built so you didn’t have to spend every penny in cash flow on repairs.

Should Real Estate Investors Pay Cash Or Finance?

We previously discussed how much cash someone might need in order to buy a rental property and that got me to thinking about a question many real estate investors are faced with when making a purchase decision: Cash or finance?

For many of us it isn’t even an option. We have to finance because we don’t have enough cash to purchase a property outright. But what if we did have $150,000 in liquid assets? Would it make more sense to put it all on one house or break it up and buy two or three properties?

A cash buyer with a $150,000 spending limit could only buy one single family house in Central Oregon. With that one house, a real estate investor could reasonably expect $1100/month in rent income less $40/month for homeowner’s insurance and $145/month for property taxes. That translates to 7.3 percent return on cash investment in a year. Assuming an average annual appreciation in the value of the house at 3 percent a year, total return on cash would be 10.3 percent/year.

Instead of buying one house with that $150,000, lets say our investor chose to buy three $150,000 houses with 25 percent down.* Down payment plus 3% for closing costs would equal $42,000 cash to close for each house or $126,000 for all three houses. The principal and interest payment would be $621.23 (@ 5.25%) and if we add homeowner’s insurance ($40/month) and property taxes ($145/month) the total monthly payment for each house would be $806.

Assuming that each house would rent for $1100 a month our investor would have positive cash flow each month of $882 or 7 percent return on cash each year (total for all three houses). That number, compared to the return of the all cash purchase is lacking just a bit but then we haven’t factored in appreciation yet. If we again assume that each house will appreciate 3 percent/year, the return on cash invested jumps up to 16 percent.

A better return on cash invested isn’t the only benefit our real estate investor gets by financing three houses. Money is still at historically cheap levels. If you think mortgage interest rates will go back below 4% in the next five years please raise your hand. If you raised your hand you are either an eternal optimist or you don’t keep up with current events. Borrowing money now is a great hedge against rising interest rates. Do you think our investor would rather borrow money now at 5.5 percent or later at 7.5 percent?

Financing rental properties isn’t just a hedge against rising interest rates but it also serves to shift some of the risk to the lender. Whether our investor chooses to invest in one $150,000 rental property or three, the risk to the investor who borrows money is as low as $42,000 per property financed compared to $150,000 for a cash purchase in this example.

The thing is, some people don’t look at risk that way. Some real estate investors want nothing to do with a bank or financing and would feel much more comfortable knowing that their investment is 100% paid for. Investing can be as much about being comfortable with where and how your money is invested as it can be about making money. What is important is that you understand the options available and how those options might affect your ability to sleep at night.

*It is possible to buy a rental house with only 20 percent down (conventional financing) but for the purposes of this post we are using the more common requirement of 25 percent down payment.

How Much Cash Do I Need To Invest in Real Estate?

We have all heard about the cash investors that have been in the news so much over the last few years. Based on those news reports it sounds like the only way a person can become a real estate investor is if they are fortunate enough to have piles of cash. The good news is, that isn’t true. You don’t have to pay all cash for a rental property. It is possible to buy a single family investment property with less than 30% cash to close, including repairs.

Down payment: There are a few variables that can affect the amount a lender will require for down payment. Credit score and type of property being purchased have the biggest impact on down payment. Typically a borrower who has a middle credit score of 680 or better will be able to qualify for what is called a conforming loan. “Conforming” refers to Fannie Mae and Freddie Mac lending guidelines. A borrower who qualifies for a conforming mortgage can expect a minimum down payment for a single family investment property at 20 percent of the purchase price. Investors will need a down payment of 25 percent for properties with two to four dwelling units.

Closing costs: Typically, in Bend, Oregon you can expect that closing costs will be three percent of the purchase price or less. That isn’t always true but more often than not it is. A good loan officer and title company rep should be able to give you an estimate that is right on the money as long as the closing date doesn’t change.

Cash reserves: At the time of closing the lender will require the borrower to have cash reserves equal to six months of mortgage payments. For purposes of calculating cash reserves the monthly payment is considered to include principal, interest, taxes and insurance. Once the purchase has closed the borrower is not required to maintain those reserves but would be wise to do so.

Interest rate: Plan on the difference in rates between a mortgage for an owner occupied home and a rental home being half of one percent.

Repairs: Most real estate investors are not looking for a move-in ready property but one they can buy at a discount. That discount usually comes with some needed repairs. Those repairs can be anything from paint and carpet to a new roof and a furnace. Each investor has their own threshold for how many and what kind of repairs they are willing to undertake. It is important for an investor to know what those repairs will be and budget for them as early in the process of buying a property as possible.

Here is an example of how to figure out how much cash a person buying their first investment property might need:

Purchase price of single family home – $125,000
20% down payment – $25,000
Buyer’s closing costs @ 3% of purchase price – $3750
Repairs – $3000
Property taxes – $1500/year or $125/month
Homeowners insurance – $450/year or $37.50/month
Principal and interest @ 5.25% – $552.20
Principal, interest, taxes and insurance – $714.70

Total cash needed: $36,038.20 = Down payment $25,000 + Closing costs $3750 + Six months PITI ($714.70 x 6) + Repairs $3000