newbie needs advice very badly! - Posted by Alex Gonta

Real Estate Investing Retail
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Posted by Alex on June 07, 2006 at 06:37:52:

Much, much thanks for excellent advice, as before it is very good. In terms of the rental application fee, I was planning to eat the cost of doing credit checks and so forth per tenant on my own, not have the tenants do that. I simply wanted social security numbers, employment verification and so forth. I want to be able to report to credit bureaus non payment, and if things get really bad, have judgements or wage garnishment done for non payment. In other words, I hope for the best, but it takes a very long time to remove a bad tenant in this state. Even for non payment, or “nuisence behavior” as defined in a lease, a judge is typically more on the side of tenant than the landlord, and you can possibly go for 4 months with no rental income in some cases I have heard. I anticipate positive things, but need to be prepared for negative things as well. You are in a constant credit relationship with your tenants and late payment, non payment, and so forth are all part of that relationship. I also have some forms I intended to use to authorize automatic ACH withdrawals from tenants checking account into landlord’s account and I’ve found a couple of companies, that with tenants written permission, can let you setup this mechanism. I intended to give a rent discount in exchange for being allowed ACH withdrawals.

Again,much thanks!

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newbie needs advice very badly! - Posted by Alex Gonta

Posted by Alex Gonta on June 04, 2006 at 09:26:49:

Need advice and not sure what to do. I’m a new investor looking to buy a 4plex in Jersey City, New Jersey. The city is next to Manhattan so great rental market because the city offers many amenities, shopping and local job market and neary by NYC market make this city “New York’s 5th borough”. I also want to invest “close to home” in order feel comfortable with investment as I get my feet wet, and I didn’t feel comfortable with investing outside my own city initially. Decided to go for a multi-family instead of single family because was assured cash flow at less than full occupancy.

My property I’m looking at is at “retail price”,not “wholesale price” and I tried looking at rehab properties initially, but found I didn’t have the cash reserves to support a repair project and didn’t have the holding cash or the stomach for buying a property for a quick flip, since it requires deeper pockets than I have at this time.

Looked at properties for 3.5 months with real estate agent. Saw landlord situation was the most realistic for me. Saw very few with positive cash flow. The relationshp of asking price in this hot market as compared to total rents was not there simply. Saw very few in good condition that didn’t require major work, in terms of plumbing or sewage. Many of the properties had low quality tenants, that have gotten used to living in substandard conditions and got used to living under a “slum landlord”.

Finally found a property in exceptionally good condition near Bayonne NJ. Asking price was originally 505k, and then reduced to 485k. Offered seller $450k, or 90% and was countered at $460k, or 93%.

It’s a 4 plex. It breaks even with 3 out of 4 tenants. Here’s the break down: Taxes=6847, Insurance=1700, water+sewer=800, and repair reserve is $1200, but the property needs absolutely zero work. Here’s the numbers:

Gross rents= $57,336
Mortgage Expense= $34,888.46
Fixed Expenses= $11,732.00
Repair Escrow= $1,200.00
Total Yrly Expenses= $47,820.46
Yearly Cash flow= 9,515.54
Monthly Cash flow= 792.96

Financing first mortgage as a 5 Year ARM and a downpayment mortgage for $10%. My concern is that I need to put down 46,000, or 10% of the downpayment plus closing costs and points, for a total tune of about $65,000, to get only about $800 bucks a month. I’m borrowing the downpayment money as a Line of credit against my home. So my LOC costs me, interest only, $404/month so my effective cash flow in reality, is only about $400 per month.

Yes, I have tax advantages and long term appreciation as my gain, but dealing with tenants and so forth is alot of work for only $400 bucks per month and a major risk for taking on an additional mortgage and alot of responsibilites.

Since the return on investment is not a cash on cash return, I figure it will take me at least 5 years to recoup my initial downpayment money. Area is safe area, but not the best in the city, but not high crime. The rents are $1,350, $1350, $728 and $900. If the two high paying tenants leave, I feel it will take time to re-rent and I’ll have negative cash flow. One is new tenant and the other $1350 tenant is leaving. Asking current owner to re-rent as soon as possible to close the sale.

I’ve been thinking about investing and getting out of a job for a long time. I don’t want to be on the fence forever, and want to start investing. The house is in good shape and has good rent roll. Good tenants, seems like. In this hot, overpriced market, it has positive cash flow at least.

What is advice? Do I buy, or do I wait?

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Re: newbie needs advice very badly! - Posted by Alex

Posted by Alex on June 07, 2006 at 09:09:50:

Wanted to follow up on my own post: the cash flow takes into account a 5th tenant in the basement at $400/month, which is how I reached the above numbers. Additionally, my loans are roughly as follows: 80% of 460k at 7% on a 5yr ARM, with 1pt paid in order to get that rate. The 10%, or 46000 as a 2nd mortgage, at 8% on a 30yr note, and the LOC at 7%, or prime, and it’s right now 7%. I have a one time option to convert the LOC into a regular home equity loan and lock in the rate, but then, the payment goes up,because it self amortizes and payment would go up enough to cover principal, not interst only. My thinking was that the $404/month for the LOC comes from the basement tenant alone, and if I added about $440/month from my own pocket, not the property, I could pay down the LOC, which would in about 6 years as my “exit” strategy. That way, I always have equity in my home, and furthermore, my equity in the rental property is my initial downpayment, because in the early years of the loan, the principal paydown is very neglibible.

I anticipate prices to stay somewhat flat going forward, not do 20% or more appreciation like we have been seeing in the low interest rate market. Also, a very conservative appreciation rate of 4% is a safe assumption.

So essentially, I’m starting off the equity in the rental property with borrowed money, but if I pay down that borrowed money in 6 years approximately, it will be “real money”. Even if prices stay flat in the next few years, and only appreciate 4% per year, or not at all, the loan paydown alone would always gaurantee me positive equity at all times. I also don’t believe in interest only loans, because I think it’s crazy to eat negative amortization to get a little extra cash flow per month.

I look upon this business as “equity farming” from several rental properties, that your tenants buy down for you.

Just wanted to clarify my numbers in my post.

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Re: newbie needs advice very badly! - Posted by speednxs

Posted by speednxs on June 05, 2006 at 09:51:27:

You did quite a good job at analysing the numbers. You do seem to use 100% occupancy. 90% occupancy is a bit fairer. Believe me, it can get worse than that.

Try to remember that you are trying to 100% finance this property. Every dollar is borrowed and you are expecting this whole debt service to be covered by rent. This is making something out of nothing (down). Of course, your time and effort will be substantial. If it will make you feel better I own a 500K condo free and clear in California that maybe net cash flows $800 a month. So I have just a bit more money tied up in that than you will. Everything is relative.

Since this isn’t “worth your effort now” will it be in five years? What do you expect the rents to be? The value of the property should at least track rent increases.

If you don’t do this deal, what will you invest in and what will be the return? A price has to be paid to get wealth in real estate. There is no free lunch. If you do buy and hold you are going to be putting in substantial effort for the next 5 - 10 years. If you are going to quit after a year or two, don’t do it. Flipping is for people who need immediate gratification.

I would try to get a fixed mortgage even if it lowers your cash flow even more. Five years from now you could really regret that adjustable. You can always refi if rates drop for even a little while.

Good Luck

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Re: newbie needs advice very badly! - Posted by Alex

Posted by Alex on June 04, 2006 at 21:49:55:

Quick follow up to my own post. Being a landlord is not something I’ve ever done before. Not enough cash flow to hire property management company either, so I’d have to manage it myself. This is not a quick exit strategy. Any ideas?

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Re: newbie needs advice very badly! - Posted by Alex

Posted by Alex on June 05, 2006 at 10:31:38:

Thank you very, very much for your reply. I very much appreciate the answer. Yes, you are correct, I shouldn’t complain since this is a no-money down deal.
In terms of the numbers, I did the math initially counting the $400/month illegal basement tenant that helps with the cash flow. You see, the property is legally a 4 family, but the 5th tenant is a bonus. However, he may or may not be a long term tenant.
At the rent he is paying, he can’t find such rent anywhere in this city, so he should be happy, be if the building inspector comes when I get a green card for the building, I don’t know what to do with him,
except maybe ask him to go for a long day at the mall and put his stuff temporarily under lock and key in a storage room in the basement that is separate from the living space. Just kidding. :slight_smile:

In terms of the actual tenants, the two highest grossing tenants have 3 bedroom apartments that are in excellent shape, but the two lower grossing tenants have one bedroom apartments. The vacancy factor hurts me differently depending upon which of the 4 of these tenants move out. If either of the two higher grossing tenants move out, I have $880/month negative cash flow, but if one of the lower cost tenants move out, I have only $200 per month positive cash flow instead of $700, so it’s not that big of a deal. Overall, since I’m covering all debt service from rental income,
I’m not truly complaining, just very, very nervous to take such a big step. I also realize that I need a “buy-and-hold” strategy to be a landlord and I know my MINIMUM time frame is at least 6 years and 10 years is more realistic.

I likewise know, that if I don’t take the leap now, prices will be higher and interest rates also higher, so rents will not keep up in relationship to increasing prices, so this will be even harder to do later.

There are a couple of main concerns that I have and I hope you can help me with this a bit:

a) My $404/month payment on my LOC is covering interest only. I need to pay at least $880 per month to truly retire the debt of $65000 in 80 months, or roughly 6.5 years. (7%-8% variable interest).
Do I add income from salary to recover this debt, or simply wait 6 years and wait for the equity of this property to grow enough, so if I should sell, I can recover my initial $65k at that time, plus put some money in my pocket at that time? Or do I retire the
debt faster on my own?

b) I don’t have any applications on existing tenants and they are all month-to-month. I’m inheriting the current landlord’s tenants and I have no knowlege of their payment history, employment verification and so forth. Legally, am I allowed to request “application” from
each tenant, which I could get their permission for credit check, employment verification and so forth, if they are already in the property? In other words,
it’s not really a rental application, since they are there already. Also, I can’t afford to take the property vacant, so I need to keep who ever is
there, and at least feel them out as their new landlord. How would go about collecting this important info?

c) I intend to have each tenant sign fresh leases with me, drawn up by my attorney, no matter what leases they already have, since they are all on month to month leases anyhow right now.

d) Finally, I work full time and will manage the property only part time. I will glady do all the repairs, if any are needed to keep the tenants happy,
but I don’t have enough cash flow to cover a property management company,so I plan to be “hands-on” landlord. I know many handy men that have worked for me. Is this sound?

(As a side note, I plan to bank all the positive cash flow received for the first year as a reserve and not touch it and only plan to put the cash flow in my pocket in my 2nd year).

I’m just very nervous now, since this is my first real deal and I want to do it, but I’m nervous.
On paper, all looks good: condition of property, cash flow and so forth.

Any advice is highly appreciated. Again, thank you.

Alex

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Re: newbie needs advice very badly! - Posted by speednxs

Posted by speednxs on June 06, 2006 at 09:49:54:

>Do I add income from salary to recover this debt, or simply wait 6 years and wait for the equity of this property to grow enough, so if I should sell, I can recover my initial $65k at that time, plus put some money in my pocket at that time? Or do I retire the
debt faster on my own?

I would use your LOC as working capital. If you have any excess capital in a given month, use it to pay off part of the LOC. If you need money for a large repair, take money out of the LOC. If you truly have positive cash flow, it will be paid down over time. I personally think paying off the LOC with salary is a good idea. It’s like getting a 7 - 8% risk free rate at the bank with discretionary money. You ought to tape your projection on expenses to the refrigerator. I’ll bet you have underestimated repairs. When your first year is up, figure out actual expenses and tape it next to that. This is how you get better at evaluating your next deal (even if it is 10 years down the road.)

>c) I intend to have each tenant sign fresh leases with me, drawn up by my attorney, no matter what leases they already have, since they are all on month to month leases anyhow right now

This seems reasonable to me. I would grandfather in your existing tenants and just have them sign a standard agreement. Asking for credit checks and employment verification is pushy. It’s not their fault their landlord is changing. Asking a $25 credit check fee for existing tenants is REALLY unconscionable. Photo copy the front and back of rent checks from each tenant in case you ever need to track them down. Ask for a photo copy of driver’s licenses for new applicants. Feel free to do all the above going forward with NEW tenants. This is a business and your tenants are your customers, not your friends and not people to be exploited. Providing service to your customers is how you earn money. So provide some service. They essentially have an existing contract which you should respect.

>d) Finally, I work full time and will manage the property only part time. I will glady do all the repairs, if any are needed to keep the tenants happy,
but I don’t have enough cash flow to cover a property management company,so I plan to be “hands-on” landlord. I know many handy men that have worked for me. Is this sound?

You ABSOLUTELY should be the property manager. This is how you learn the business of buy and hold. Every problem is a learning experience for the future. Usually you just notice the pain in the moment, but weeks later your realise that there is something you could do to avoid repeating the incident in the future. After your first 100 problems you’ll be heck-on-wheels for your next investment (and running your current properties.) I keep a lab notebook diary that I keep all the names and telephone numbers of repair people and requests for repairs (receipts I keep separately). Pretty much any info regarding the rentals. This way I don’t have scraps of paper floating around with that phone number I used to have 14 months ago. Taping busness cards etc. in is just fine. I transcribe the important bits of info into a computer file. If your ever have to prove that you are a real landlord (IRS, loan officer), this ought to do it.

Try not to take the above as criticism. You are doing much better at finding and analysing your first deal than I did. Most people who tell you that your can’t do it, are really saying they can’t do it. It’s your personal decision to take on the risk and effort in order to reap the reward.

Good Luck