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What About “Cap Rate?”

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By Bruce Kellogg

It’s a popular and confusing measure!

You had to ask! It’s probably the most used real estate investment metric lately. Many people, syndicators and trainers especially, are talking about it. It turns out that there are more than one version of it, and they are not consistent. So, here goes!

Realtor.com’s Version

Realtor.com describes Cap Rate as “How much you earn on an investment”, and they measure it as Net Annual Income divided by Purchase Price, expressed as a percentage. They say to calculate the annual rent, but what if there are coin laundry machines, and the garages are rented extra, or rented as storage units? Do you see the problem here? Now, should the Purchase Price include closing costs, and the new roof that was installed immediately after closing? Do you see the problem here?

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One thing all versions have in common is that debt on the property is not included. It is computed as though there is no debt. That is how  Cap Rates can compare properties with each-other. So that’s good.

Realtor.com quotes a Realtor and attorney who says, “Cap Rate is a proxy for determining the risk of an investment.” Hmmm. More on that shortly.

Realtor.com says Cap Rates usually range from 4% to 12%. A lower rate makes the property more expensive, usually.

Investopedia’s Version

Investopedia regards Cap Rate as a “rate-of-return on investment” that can be used to “compare similar real estate investments”. It “indicates the property’s intrinsic, natural, and unlevered rate of return.” Yes, intrinsic and natural. We like that!

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So, Investopedia says Cap Rate = Net Operating Income divided by Current Market Value. Except when it says Net Operating Income divided by Purchase Price. The first one differs from Realtor.com’s definition, but the second one is the same. Clear now?

Some sources say to use actual rents and expenses from the previous year to compute a Cap Rate. Nowadays with so much syndication going on, they go beyond that to PROJECTING income, costs, and Cap Rates out 3,5,7 years for the life of the project. One prominent national syndicator with about 30 projects recently said he likes to buy in the 5-Cap range, add value, then sell in the 3-Cap range. Now that multiunit sales are 5-Cap or higher due to increased interest rates and wealthy clients becoming less wealthy anymore, he might find his model being a challenge. Cap Rates generally rise as interest rates rise, and as Yogi Berra famously said, “Predicting is risky, especially when it’s about the future.”

What’s this about risk?

According to Investopedia “a lower Cap Rate corresponds to a better valuation and a better prospect of returns with a lower level of risk. On the other hand, a higher value of Cap Rate implies relatively lower prospects of return on property investment, and hence a higher level of risk.”

So, here are some of the risks they mention:

  1. Age, location, and status of the property
  2. Tenants’ solvency and regular receipt of rentals
  3. Term and structure of tenant lease(s)
  4. The overall market rate of the property and the factors affecting its valuation
  5. Property type: multifamily, office, industrial, retail, or recreational
  6. Macroeconomic fundamentals of the region as well as factors impacting tenants’ businesses

As a practical example, suppose you have two indentical 20 year-old 4-plexes. One is next to a small shopping center containing a convenience store, a nail parlor, a bar, and a “strip club”. The second one is next to a good-size church with a medical clinic across the street. Which is likely to have the lower (“better”) Cap Rate? So, that’s risk.

An Educational Example

Exhibit “A” is a listing of a vacant 78 year 0ld 2082 sf. house on a city lot. The agents say it’s a single-family residence (SFR), but it can be turned into a Residential Care Facility as a “value add” opportunity. Maybe add an ADU since the lot size is apparently sufficient.

The second page shows a Cap Rate of 16.40%! That’s amazing! They figured that to two decimal places on a vacant property! It’s not really a miracle. They PROJECTED the Residential Care Home on to the property.

Here is the lesson:

This is a PROJECTED Cap Rate. Who knows what will happen? It is basically meaningless. Yogi was right.

Conclusion

Cap Rate is one measure out of about ten that are useful for real estate investment analysis. It has value on larger projects like multiunits and other commercial properties, but on smaller residentials, say 1-20 units, it’s not necessary. Just compute the cash flow, and see if you like it.

Cap Rate has several formulas, which can be confusing and even contradictory. If you’ve decided to use it, select a formula that has meaning for you and apply it consistently to your investment decisionmaking.

Calculating investment metrics is “desk work”. Necessary, of course. But also needed is “field work”. Go investigate the property. Where are the bar and “strip club”? Or the church and medical center? Remember, you can improve the property, but not the neighborhood.

And don’t put too much stock in anybody’s projections. The property needs to make sense today.

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor in California for 44 years. He purchased about 350 investment properties for himself, mostly with high leverage and tax-deferred exchanges. In the process, he made three fortunes, and experienced three real estate downturns since 1980. He has transacted about 550 properties for clients, creating fortunes for several. His first book, Real Estate Investing Wisdom, is in publication, and he can be reached at [email protected] or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

Essential Real Estate Calculations

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Image from Pixabay

By Bruce Kellogg

Introduction – Why Calculate and Analyze?

This is probably intuitive to most investors, but we calculate and analyze properties for the following reasons:

  • To understand present operating performance.
  • To project future performance under different scenarios.
  • To compare alternative investment opportunities.

#1 – Cash Flow Analysis

Figure 1 is a simple EXCEL™ spreadsheet that can be used for initial analysis of a property. Scenario A is typically the property’s present numbers. Scenario B is for “what if” analyses such as increasing rents, reducing selected expenses, or refinancing the loan structure. Figure 2 contains a larger list of expenses that should be used on this spreadsheet, and any others, to ensure that everything is accounted for.

Fig.1

A “quick and dirty” way to avoid applying every expense to a cash flow analysis is to estimate a percentage of rents, and use that. Say, use 35% if the property is under 5 years old, and the tenants pay most or all of the utilities. Go up to 60% of rents if the building is old, poorly-maintained, or the landlord pays most or all of the utilities. Initially, you might just use 50%. That’s pretty common. As you gain more experience, you can vary up or down, as described here.

#2 – Monthly Rent-to-Cost Ratio

This metric is used for initial screening, to see if you want to evaluate the property any further. Just divide the Monthly Rent by the Total Cost (Purchase Price + Rehab + Acquisition Costs), and express it as a percentage. You might want to do this twice, once for the present rents, then again for market rents if there is much difference. A result below 1.0% is not worth analyzing further under most circumstances. Above 1.2% you’re getting somewhere.

#3 – Gross Rent Multiplier (GRM)

The Gross Rent Multiplier is computed by dividing the Sale Price by the Gross Annual Rents. It is used to roughly compare properties as a screening method where higher is better.  One caveat is that operating expenses are not considered, particularly who pays for utilities can make a big difference. It’s useful, but rough.

Fig.2

#4 – Capitalization (Cap) Rate

This is one of the most useful metrics for comparing real estate investment opportunities. It is best done using actual income and expenses from the previous year. Using it for pro forma performance projections is not as useful.

Cap Rate is computed by dividing the Net Operating Income (NOI) by the Total Cost (per #2, above), then multiplying by 100. Generally-speaking, the higher the Cap Rate, the better the cash flow. But one needs to consider property and location quality, as well because although a slum property might have a high Cap Rate, it still probably is an inferior investment. Inexperienced investors are misled by this sometimes.

Note that Cap Rate does not include debt-servicing costs. This is why different investments can be compared so readily using it.

#5 – Debt Service Coverage Ratio (DSCR)

DSCR is a favorite metric for lenders because it shows them how well the property will service the debt on it. It is computed by dividing Net Operating Income (NOI) by the Annual Debt Service, which includes both principal and interest, but not taxes and insurance. Most institutional lenders want the DSCR to be at least 1.2.

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#6 – Return on Investment (ROI)

Return-on-Investment (ROI) is one of the best measures of how your investment is performing. It is computed by taking the Gain on Investment minus the Cost of Investment, divided by the Cost of Investment. The Annualized Return is computed by taking the ROI and dividing it by the number of years the property has been owned.

#7 – Cash-on-Cash Return

Most of the time, investing involves the injection of cash which, for most investors, is limited. So, they want to know, “What is my cash doing for me lately?” This metric is computed by subtracting the Annual Debt Service from the Net Operating Income (NOI), then dividing by Cash in the Property. It is calculated on an annual basis, and is not appropriate for the first year. Additionally, a “cash out” refinancing will end its usefulness.

#8 – Internal Rate of Return (IRR)

IRR is especially useful when comparing returns on different asset classes. It is sometimes called “Discounted Cash Flow Rate of Return” because annual cash flows are discounted back to the total initial investment. The rate at which these equal zero is the IRR. It requires a financial calculator or software program to obtain this result. The HP-12C calculator and EXCEL IRR function are examples.

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Limitations

  • The real estate calculations presented here all depend on quality data, which must be verified, if necessary. Some sources, like MLS listings and brokerage marketing materials, sometimes have errors or omissions.
  • These calculations assume the investment property will not experience a “Black Swan Event”. The COVID-19 pandemic is an example.
  • Additionally, performing calculations is “desk work”. It’s essential, but it needs to be coupled with “field work” for an intelligent investment to be made.
  • Finally, the author recommends that after an investor does their calculations and conclusions, they share these with an experienced fellow investor, mentor, or consultant as a check on their work.

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

Mr. Kellogg is a contributor and copy editor for two national real estate wealth-building magazines: Realty411, and REI Wealth Magazine. He is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America– 2019.

He is available for consulting with syndication, turnkey, joint-venture, and other property purchasers and note investors nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

The Deed-in-Lieu-of-Foreclosure

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Image from Pixabay

By Bruce Kellogg

The Wrong Way

At a recent meet-up, I met a man who had recovered a property from a defaulting borrower on a note they had between them. Looking to save costs, the note-holder accepted a deed and promptly recorded it. Later, when he went to refinance, he discovered that several liens and judgments had attached to the title of the property. In total, they wiped out his equity! Sad tale, but true, and this wrong way of doing a deed-in-lieu-of-foreclosure happens a lot. So, what is the right way that protects both the defaulting borrower and the recovering note-holder?

Image from Pixabay

No. 1 Open an escrow, and order a title report. Specify that involuntary liens (liens, judgments, etc.) are to be searched as well as voluntary liens (mortgages, deeds-of-trust). Expect to buy title insurance and pay escrow costs.

No. 2 If you received an insurance policy from the borrower, and were named as “mortgagee”, or “additional insured”, call the company and find out if the policy is still in effect. If it is not, order a policy of your own. You need protection.

No. 3 Check the property taxes with the County Tax Collector. If they are delinquent, pay them current. Get a receipt to give to escrow because some counties are slow to update their records.

No. 4 Find out the status of any senior loans. Call first, but if the lender refuses due to privacy reasons, have escrow or your attorney make the request. Pay the senior loans current, preferably through escrow. If paying them yourself, be sure to get a receipt for escrow.

No. 5 See the property. If it is within driving distance, visit it personally. If not, hire a service like www.wegolook.com to go take pictures.

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Caution: If the property is rented, it is advisable not to step on the property or engage anyone there in conversation.

No. 6 If the property is a rental, try to get the defaulting borrower to turn over the security deposits and any advance rents. You might not get this.

No. 7 When the title report comes back, you need to check for any liens and judgments. If these are present, then you need to foreclose to shed them from your title.(This is what the unfortunate lender above failed to do.) You have no choice.

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No. 8 If there are no involuntary liens, or small ones (e.g., garbage liens) that you are willing to pay in escrow, then have a Deed-in-Lieu-of-Foreclosure drawn up for the defaulting borrowers to sign. These deeds are special because they have a recitation of several paragraphs on them called an “Estoppel Affidavit”. The borrowers affirm that they are deeding freely, without coercion or duress, and are not being compensated beyond forgiveness of their debt.

No. 9 If the borrowers go through this process, and escrow closes, then you need to return their original note marked “PAID” to them. In addition, escrow needs you to sign a Full Reconveyance of the mortgage or deed-of-trust in order to insure your clear title.

And that’s the right way!

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

Mr. Kellogg is a contributor and copy editor for two national real estate wealth-building magazines: Realty411, and REI Wealth Magazine. He is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America– 2019.

He is available for consulting with syndication, turnkey, joint-venture, and other property purchasers and note investors nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

Rates are Rising! What’s Ahead?

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Image from Pixabay

By Bruce Kellogg

The Reversing Interest Rate Trend

In 1980, only two years into real estate investing, I purchased two rental houses with 18% loans from Glendale Federal Savings, which is long gone. So are the two rentals, lost to foreclosure because I could not handle the resulting negative cash flow.

18% was the peak in mortgage rates at the time. In the subsequent 42 years, they have drifted down to the recent 3% range, largely due to fiscal and monetary actions taken by the U.S. government intended to manage the economy.

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Now, due to rampant inflation reaching 8.5% annually, the Federal Reserve Board has begun to raise rates rapidly. They never quantify their intentions, but reputable financial observers are predicting increases of 1.5% or more over the rest of 2022.

I believe that the long-term trend in interest rates is reversing now. I think this will change many aspects of the real estate industry in major ways. After 44 years in the business, I feel qualified to express what I envision happening in several areas. I’m thinking about what will be happening December 31, 2022 and beyond. Let’s see!

#1 – Mortgage rates have just reached 5.25% for conforming 30-year fixed rate loans. Adding in the Fed’s 1.5%, we get a conservative 6.75%. I say “conservative” because lenders will add 0.5% or so to protect themselves in the rising trend. So, 7.25% is also possible. Adjustable-Rate Mortgages (ARMs) will be cheaper for borrowers, but riskier in a rising rate environment.

#2 – Car loans are usually close to mortgage loans. Several years ago my son got one below 2% (barely). If these go to 7-8%, a lot fewer new cars will be bought. Vehicle, heavy equipment, and some consumer-financed goods will suffer sales declines. Production cuts and layoffs could result.

Image from Pixabay

#3 – The Federal Debt portfolio is huge and varied. But new, long-term federal bond issues could reach 5-5.5%. Recently in the 2% range, this will increasingly make it harder for the U.S. to service its debt. Additional borrowing, or tax increases, could be the result. Oh, oh!

#4 – SFR (Single-Family Residence) Listings will be low and will stay low. See the diagram (Source: Axios). 92% of homeowners say their home is affordable for them now. Houses are appreciating nicely so far. So, why list, find a new place, move, and pay more??? Some will list due to a job relocation, divorce, inheritance windfall, but not many for a “move up”. Homeowners are “set” at this time.

#5 – Buyers’ Offers will be fewer. With fewer listings, higher prices, and higher rates, the number of buyers will drop off. Prices could decline after a while. Some markets are “topping out” already. This is a local phenomenon, so pay attention!

#6 – Refinances were off 80% last week. This industry is destined to be hit hard. Loan agents will be leaving. Offices will be consolidating or closing. There’s no stopping it.

#7 – Real Estate Agents will thin out, also. Those with small clientele and/or high overhead (e.g., poor commission splits) will not make it. Some will downsize, prospect more, and further educate themselves. Grow professionally, and “hustle harder”!

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#8 – Real Estate Brokerages will also need to retrench. They have been on an “agent acquisition binge” for several years on the belief that more agents = more deals = more income. This has been true, but going forward many agents will add to costs, but not to revenues. Cull the flock. Get lean for the uncertain future.

#9 – “Flippers” are dropping out, and they should. Material costs are rising. There are supply shortages. Loans are more costly. Deep-discount acquisitions are scarce. Buyers are fewer and reluctant. I heard a speaker say 80% of “flippers” do one deal, then quit. In the coming times, that makes sense.

#10 – Syndicators will need to throttle back, also. Especially apartments, mini storage, industrial warehousing, and student housing, have been on a tear nationally this market cycle. “Gurus” have been teaching, and novices have been jumping in. The party is becoming more subdued. Lenders are raising rates and qualifying criteria. Investors are pulling in their horns. Opportunities are fewer and weaker. The bloom is off for syndication.

#11 – Ibuyers are companies, usually brokerages, who buy houses from homeowners as a service, refresh the home, then market it. They have abundant “Wall $treet money”, and they aim for a 7% margin or so. Most are losing money on this business model even in the current rising market. When the market turns, this will no longer be viable for them.

Image from Pixabay

#12 – Real Estate Technology Startups are a new model funded by venture capital and piloted by technology entrepreneurs. Their model involves combining real estate brokerage, lending, title work, and more, to make the process seamless for the consumer. This has been tried for 70 years already, but these people believe that the injection of technology is the key to it finally working. Two of them tried to recruit me. Amazingly, they offer a salary, bonus, health insurance, vacation, etc., in the traditional corporate mode. It was nothing like the old-style brokerage model! They have raised money in the $300-700 million range, so they can hold out a long time when the real estate industry inevitably contracts in the coming years. So, we’ll see.

#13. – Hedge Funds and other institutional investment vehicles have purchased tens of thousands of houses this market cycle. They have “crowded out” traditional homebuyers in many locations, and this has become upsetting to some. When this started, hedge finds targeted yields in the 6-8% range. Now that inflation is in the 8.5% range already and still rising, the yield to the investors is “walking backward”. Enough of this, and these funds might start liquidating their houses in substantial quantities. This could strongly impact SFR markets where it occurs. Some signs of this are starting to develop.

#14 – NNN Lease Properties are commercial properties that are sold to investors who want no involvement and just want a net check every month. Often they have a single tenant, like a Subway restaurant or a U.S. Post Office branch, which is very secure. During a real estate industry downturn, these properties become more risky. If the tenant vacates, or worse, files bankruptcy, things could become quite complicated. I had a client who owned six restaurant buildings during the 2008 Great Recession that a commercial broker had sold to him. Two stopped paying, and two went vacant. We saved them all, but only because he had cash reserves. That will be important in the days ahead.

Image from Pixabay

#15 – Homebuilders had ideal conditions until recently as they worked on the “housing shortage.” Since then: A) Materials prices went up. B) Supply chain delays got underway. C) Mortgage rates began increasing. D) Fewer buyers qualified, and more became reluctant. Fortunately, like farmers, homebuilders stay on top of their conditions. For now, many have gone to “building to order” rather than “building on speculation”. The future will dictate what else needs to be done.

Conclusion

Trends give rise to events, and the trend here is the increase in interest rates, probably over the long term. The foregoing discussions are presented to stimulate your anticipation and response to events as they unfold. Good luck, and I hope you enjoy the ride!

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

Mr. Kellogg is a contributor and copy editor for two national real estate wealth-building magazines: Realty411, and REI Wealth Magazine. He is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America– 2019.

He is available for consulting with syndication, turnkey, joint-venture, and other property purchasers and note investors nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

A Primer on “Creative Financing”

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Image from Pixabay

By Bruce Kellogg

History

Modern awareness of “Creative Financing” began about 1980 with Robert G. Allen’s famous book, Nothing Down (Fig. 1). For the next five years or so, a flurry of books were published on related subjects (Fig. 2 and 3). I “grew up” in real estate during this period, and accumulated the library shown in Fig. 4 in addition to closing over 600 transactions using these techniques. In the process, I became known as a “leverage mechanic”. Now, I am preparing a comprehensive book titled, Leveraging Real Estate – Your Guide to Creative Financing. This article is a primer on the subject.

Fig.1

What is “Creative Financing”?

The original use of the term “Creative Financing” applied to anything that was not “CTNL”, “cash-to-new-loan”, when purchasing a property. Then it got narrowed down to financing that was “created” as part of the transaction, such as seller financing. Now, it has opened up to mean all techniques that display imagination on the part of the parties. I like this definition best!

Seller Financing

The most common form of “Creative Financing” today is still “Seller Financing”, or “Owner Carryback Financing”. The following Realty411 magazine articles thoroughly present this subject.

REI Wealth Monthly #49 “Seller Carryback Note Terms”

Real Estate Wealth Vol. 1, 2018 “Seller Financing 101”

Realty411 Vol. 6 No. 4  “Seller Finance 101”

Realty411 Vol. 7 No. 2  “Seller Carryback Note Terms”

Best of Realty411  “Seller Finance 101”

Fig.2

Managing “Creative Financing”

In the process of using “Creative Financing”, problems could arise in two areas, negative cash flow, and balloon payments. These are thoroughly covered as follows:

REI Wealth Monthly #44  “Dealing With Negative Cash Flow”

REI Wealth Monthly #50  “Dealing With Balloon Payments”

Creative Acquiring Properties

There are other applications of “Creative Financing” besides the use of notes. The following series of articles describe 24 ways, many of which are creative.

REI Wealth Monthly, issues 34, 35, and 37.  “24 Ways to Buy”

Additionally, there are creative ways of partnering described in

Realty411 Vol. 9 No. 2  “Partnering For Profits”

Finally, there are the subjects of Options and Lease-Options which are outside the scope of this article. There is plenty on the internet.

Fig.3

Accessing the Articles

Realty411 does not have magazine back issues nor copies of past articles available. So, to provide readers a meaningful learning experience, readers can order email copies from the author as follows.

“Seller Financing 101” and “Seller Carryback Note Terms” $12.00

“Dealing With Negative Cash Flow” and “Dealing With Balloon Payments” $12.00

“24 Ways to Buy” (3 articles) $12.00

“Partnering for Profits” $8.00

Checks should be mailed to:

Bruce Kellogg

430 N. Second St. #A

San Jose, CA 95112

Additional Resources

Fig.4

For readers who are interested in learning more about “Creative Financing” techniques, some Resources (books) are included as an attachment. A internet search will be necessary because they will need to be purchased used if they are available. Of course, current books on the subject should be searched, as well. Anyone who applies themself should be able to become well-versed in “Creative Financing.”

CLICK HERE TO VIEW RESOURCES

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

Mr. Kellogg is a contributor and copy editor for two national real estate wealth-building magazines: Realty411, and REI Wealth Magazine. He is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America– 2019.

He is available for consulting with syndication, turnkey, joint-venture, and other property purchasers and note investors nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

Caveat Investor (Part 2)

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Image from Pixabay

By Bruce Kellogg

#6 – Lending

Here are four things to know about lending:

A) On a purchase situation, the appraiser will bring it in at the contract price if they can. (That’s why they ask for the sale price in advance!) They try not to come in below the contract price, but they scrupulously won’t go above it.

B) On a refinance, appraisers tend to come in lower to protect the lender. Don’t expect a high appraisal because you’ll be disappointed.

C) Do not think “No Points” is a bargain. It’s a “come-on”! Lenders seek a certain yield, so any concession on points they make up with the interest rate. There’s no free lunch.

D) My adult son started a refinance with an online lender. Part way through, he found a better deal, canceled the application, and pulled the loan package. The former loan agent howled. What do you think? Is loyalty required when you are getting a loan online?

#7 – Property Managers

Image from Pixabay

Most property managers are honest and hardworking. They deal with tenants. WHEW! No fun! But here are some caveats for you.

A) Most property managers do not make the effort to inspect unit interiors regularly, so some tenants run down the unit.

Insist on quarterly inspections. Pay extra if necessary. It’s cheaper than accumulating unit damage. If your manager won’t/doesn’t do it, it’s time for “NEXT!”

B) Some managers make work for their contractors and handypersons, some of whom are often relatives and friends. They authorize unneeded repairs. Be alert to this. (I got conned out of an $8,700 septic tank installation once. The manger was in cahoots with the county sanitarian.)

C) Some managers have “kickback” arrangements with the people they hire.

D) Some managers apply a percentage “markup” to the parts they buy. They say this compensates for the purchasing effort. This is a load of fertilizer! Simply buy the parts yourself after getting a detailed list from the manager or the contractor.

#8 – Education and Training

One buzzphrase in real estate lately is “move to the next level” or “scale up”. This is accomplished only by education, training, and experience. Yet as the real estate boom has grown, teachers, trainers, and mentors have proliferated.

Image from Pixabay

Consequently, it is essential that you pick quality contributors to your growth. Sometimes, it is hard to tell amidst all the hype.

You can be pretty confident of quality if you are involved with Realty411. Linda Pliagas, the founder and publisher, has had a career in real estate of several decades as a Realtor®, multiple investor, and journalist/publisher. Her mission is to help investors grow and succeed. Realty411 Magazine and REI Wealth Magazine have high standards for their articles, and their expos nationally have high standards for their exhibiters and presenters. Charlatans are not tolerated!

Another resource is the myself. With 40 years as a Realtor® with over 800 transactions of all kinds, including owning over 300 investment properties myself, I offer readers the benefit of my experience. See the accompanying biography for contact information.

#9 – “The Rise of the Fake Gurus”

Please go to YouTube and watch “The Rise of the Fake Gurus”, which is a 21 minute detailed expose how fake “gurus” lure their victims from free “workshops” all the way up to $40,000-60,000 “bootcamps”. Definitely watch it at least once!

Wrapup

As the market continues to heat up, new investors are entering real estate all the time. This article is meant to highlight some of the larger risks, pitfalls, and cons they will want to avoid as they grow. Best wishes with that!

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

He writes and edits copy for Realty411 and REI Wealth Monthly magazines.

Mr. Kellogg is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America – 2019.

Mr. Kellogg is available for consulting about syndication, “turnkey” investments, joint-ventures, and other property purchases nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Learn live and in real-time with Realty411. Be sure to register for our next virtual and in-person events. For all the details, please visit Realty411.com or our Eventbrite landing page, CLICK HERE.

Caveat Investor (Part 1)

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Image from Pexels

By Bruce Kellogg

Why Caveat Investor?

There have been many changes in real estate since the boom began in 2010 after the Great Recession. To name a few: 1) Real estate licensees have increased about 40%. 2) Syndicators are gobbling up apartments, self-storage, mobile home parks, and industrial warehouses. 3) Brokerage companies are paying cash and “flipping” houses using venture capitalists’ money. 4) Brokerages are hiring agents like employees with salaries, vacations, health insurance, retirement plans, and stock options. 5) Developers are building whole communities of houses for rent. There’s a lot more, of course, but no time to exhaust the subject.

See the accompanying chart. Markets appear to be in the late stage of their up-cycle. As always, change is coming.

This article is my survey of many aspects of real estate where readers and investors need to be cautious and diligent in this expansive and innovative real estate environment. Every effort was made to address the major places where investors could get cheated or financially hurt in other ways. So, here goes.

#1 – Homebuying

Many homebuyers are making offers without inspection contingencies in an attempt to win in competitive bidding. The same is true of “as is” purchasing. Buyers are also not scrutinizing property condition disclosures from sellers. All of this is risky and imprudent. Deal with this as best you can. You can always walk.

#2 – Brokers and Agents

Reportedly, 40% of the new agents in California were licensed only in the past two years. (Other places are probably similar.) The average agent does 3-4 deals per year, so they might have 8 transactions under their belt. These are beginners, or novices, even though their business card might have “senior” in their title. “Junior or apprentice” would be more like it. Pick an agent with 10 years or more of full-time experience, and over 6o closed transactions, primarily with the type of property you are working with. Hire a pro.

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The other thing you need to watch out for is agent/brokers exaggerating their accomplishments and/or qualifications. I saw a flyer recently where a pair of new agents boasted of selling 250+ listings worth $250+ million. What they had done is taken the whole company’s production and taken credit for it. Brokers and sales managers are supposed to review and approve all agent advertising, but they don’t. So protect yourself. Be skeptical of “puff” in the advertising you receive. Or ask for proof, if there is any.

 #3 – Syndications

There are a lot of trainers and ”gurus” traversing the countryside teaching how to do syndications. The attraction is that you can quit your job and become wealthy. They present testimonials, picture luxury homes, and stand next to exotic automobiles. So, a lot of sincere but inexperienced people sign up. Lately, there is a huge demand for apartments by syndications that might overpay, buy wrong properties, or mismanage the 5-7-10 year project. It’s easy to make faulty or fraudulent projections on a 10-year EXCEL spreadsheet.

The other thing is that new syndicators are taught to pay experienced syndicators with good credentials to lend their qualifications to the project for a portion of the ownership. This makes the new syndicator look better. But are they really better, or still inexperienced beginners? Would you bet your money?

#4 – Turnkey Investing

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Distance investing in “turnkey” properties can be viable if it is done right. Needed are a rehab with quality materials, all necessary inspections, and all permits signed off. Many turnkey operators skimp on these to increase their profits. A prudent investor would visit the area, inspect the property, review the  inspections and permits, and interview the potential property manager. “Armchair investing” is not enough because once you buy, it’s yours. The others could split, and you’re on your own.

I had a client who wasn’t given promised repairs. The city inspected and threatened to prosecute him in Cleveland while he lives in Palo Alto, California. He fired the do-nothing property manager, hired a new one, got the repairs done, and salvaged his situation. It’s a quality, brick home in a good area with a quality tenant and good cash flow, but a “passive investment” it was not.

#5 – Fix & Flips

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Much of the talk on TV, in the media, and online is about “fix & flips” of houses, and even larger properties. Every now and then the news reports the average profit is $60,000+ per flip. You can do one every six months, part-time! Really? Well, the $60K “profit” is not calculated to include materials, labor, permits, advertising, and holding costs. Big difference! Perhaps this is why 80% of “fix & flip” entrepreneurs reportedly quit after their first project.

Now, if you want to try it, do it right. 1) Estimate the costs accurately. 2) Estimate the “After-Repaired Value” (ARV) accurately. 3) Hire a competent, reliable contractor. 4) Select the right type of house. No two bedrooms. Too small. No Victorians. Antique money pits! (Disclosure: I live in one, built in 1898.) Ideal are 3-5 bedroom, modern-construction “tract” homes on standard city lots, bought right. Do not compromise and “reach for a deal”. Pass, and keep looking. As they say, “You make your  profit when you buy.”

Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

He writes and edits copy for Realty411 and REI Wealth Monthly magazines.

Mr. Kellogg is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America – 2019.

Mr. Kellogg is available for consulting about syndication, “turnkey” investments, joint-ventures, and other property purchases nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

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Enhanced Diligence for Syndication Investing

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By Bruce Kellogg

What About Enhanced Diligence?

In the beginning, commercial real estate brokers invented the term “due diligence”. Lacking a specific definition, it basically means, “Check it out”, when making a real estate purchase. Nowadays, the term has received wider use in home purchasing, turnkeys, syndications, and more, but its application still has no formula. This article aims to correct that for syndication investing with what can be called Enhanced Diligence.

Initial Philosophy

When an investor purchases a syndication share in a distant location from a promoter, the investor is investing in the promoter as much or more than in the property. The property could be bad, or good, or so-so. The promoter could be competent and honest, or incompetent and honest, or competent and dishonest, or incompetent and dishonest. BUT the investor’s funds are tied up for 3, 5, or 7 years, and the success or failure of the project might not be known until the end of the holding period. This is why Enhanced Diligence is so important.

A Recent Example

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There was a “meetup” attended by about 70 people with an attorney speaking on the subject of “Asset Protection”. At the close, the organizers called out, “Who here is an accredited investor? Come up to the table to learn about our multi-family syndication in the south side of Chicago.” Now, Chicago has the highest murder rate in the country by far, and the south side is where it happens. Can you just imagine the robberies, the violence, the drug dealing, the arrests, the vacancies, the turnover costs, the lawsuits, and the insurance claims? And some “real estate entrepreneurs” from the Bay Area of California are going to successfully nurture this syndication for 5 years? Uh, huh. No doubt they just graduated from some “guru’s” “boot-camp”.

The Basics

Syndication” is a generic term for a group investment. It can take the form of a joint venture (JV), Limited-Liability Corporation (LLC), Limited Partnership (LP), Tenancy-in-Common (TIC), or possibly another legal structure. The LLC is most popular lately due to the ability to pass through to the investors such things as depreciation, interest expense, operating expenses, and other deductions. A “sponsor”, or “promoter” puts the syndication together and runs it during its term.

Diligence and the Promoter

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An article appeared in the November/December, 2013 issue of Personal Real Estate Investor Magazine, entitled, “12 Ways to Earn Money as a Real Estate Syndicator”, written by Kim Lisa Taylor, Esq., a securities attorney. It very thoroughly laid out the many ways an enterprising person can get rich investing other peoples’ money. Today, there are “gurus” traversing the countryside teaching syndication. When evaluating a promoter, several things need to be investigated, as follows:
  1. What is the promoter’s background, education, and experience with similar projects?
  2. Who are the promoter’s team—accountant, property manager, attorney, etc., and what are their qualifications?
  3. How much is the promoter investing? Is it CASH, or is it “equity”, which could be anything. Beware of non-cash promoter contributions!
  4. What other projects and assets does the promoter have? Is the promoter spread too thin?
  5. Does the promoter put together serial syndications, leaving the older ones to neglect?
  6. What provision is there for removing the promoter if they are not working out? Is there any?
Under Enhanced Diligence a “background search” should be performed on every decision-maker involved in the syndication. Certainly, this is the promoter, but it also includes anyone else in authority. This involves ordering a report from Lexus-Nexus, Trans-Union, or another data base firm. The report will usually include any liens, judgments, and bankruptcies, along with addresses, professional licenses (including any revocations), relatives, phone numbers, and email addresses. Costs of reports are only a few dollars for those with subscriptions to these companies. Otherwise, call 3-5 private investigators for quotations. Their costs are under $15.00, and they have the necessary systems. The Social Security number of the promoter is not needed, and neither is their permission needed because this is a public records search. They will not know the search is being done.
C’mon, is this really necessary? It depends. If you are comfortable wiring $50,000 – 250,000 to a promoter out-of-state who you don’t know very well, then go for it. The author has discovered syndicators in bankruptcy, with federal tax liens, and civil judgments. Would you trust them with your money? You can’t know your promoter too well!

Diligence and the Property

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When it comes to the property, bear in mind that the promoter will be presenting it in its best light. Here are the primary items that need to be investigated:
  1. Age: Nothing older than age 30-35 should be considered. Syndications intended to add value to deficient older properties usually turn out poorly due to excessive rehab costs.
  2. Building Class: A=Luxury, B=Professional, C=Working Class (“Blue Collar”), D=Low Income (“War Zone”). Luxury apartments don’t cash flow as well, and low income units are, frankly, treacherous. Stick with class B or C.
  3. Pictures: Hire a service such as wegolook.com to take pictures of the property and its surroundings, or go to Google View, or Bing Street View. Properties need to be fairly clean-looking. No industrial properties or strip centers close by. Schools, a hospital, and houses of worship are a plus. You probably know “nice” when you see it. Tenants do, too!
  4. Crime Rate: Go to ciity.data.com and check out the neighborhood crime rate. While you are there, check out the school ratings and the household income. Renters are attracted to low crime areas with good schools, and you need that to keep your building full.
  5. Unemployment Rate: Go to the Bureau of Labor Statistics website, BLS.gov and check this out. It shouldn’t be more than 20% above the national average at the most.
  6. Unit Mix: The Offering Circular from the promoter will normally say how many units are studios, 1-bedroom, 2-bedroom, and so on. Avoid projects that are largely studios and ones because turnover is higher, and so are related costs.
  7. Project Plan: Also in the Offering Circular there is usually the promoter’s plan for the project to add value by remodeling, adding amenities, raising rents, and so on. Consider this carefully because all of the projected returns from the promoter depend on the plan succeeding.
  8. Rents: Go to zilpy.com and accurent.com to check out the rents given presently and projected by the promoter. If not satisfied, feel free to call the property manager to discuss them. Don’t be shy. Your investment is at stake.
  9. Market Conditions: Oftentimes these are discussed in the Offering Circular. There is no formula for evaluating this, but see if they make sense to you.

Diligence and the Deal

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Lastly, you need to evaluate the deal itself, which is described in the Offering Circular. Here is what you need to consider.
  1. Holding Period and Exit Strategy: See if this makes sense to you and fits your time frame.
  2. Dispute Resolution: How are any disputes between the investors and the promoter going to be resolved? Can the promoter be removed and replaced if necessary?
  3. Voting Rights: What voting rights do the investors actually have? Are you comfortable with that?
  4. Reporting: Reports should be monthly or quarterly.
  5. Promoter’s Fees: The Offering Circular will disclose these. There will be plenty because syndicators often set up a certain return for the investors, then pile on the fees wherever they can. See the article by Kim Lisa Taylor on the 12 ways syndicators can make money, under “Diligence and the Promoter”, above.
  6. Cash Distributions: When are cash distributions made to investors, and what are they for?
  7. Leverage: How much cash down-payment will be made, and what loan(s) are there? 30-40% down-payment is common. Be suspicious of overleveraging with anything less.
  8. Overpaying?: The commercial real estate market, especially multi-family, is “hot” right now with syndicators competing for properties and bidding them up. Your promoter could be overpaying, which would severely reduce your investment return. Usually some Comparable Sales are presented in the Offering Circular along with some discussion. Study these carefully. Does your project make sense?
  9. Project Financial Measurements: Projects are measured primarily on Internal Rate of Return (IRR), which is used to compare investments of all kinds, and on Cash-on-Cash Return, which basically expresses the productivity of the investor’s cash in the project. Promoters provide estimates of these and others in the Offering Circular. Familiarize yourself with these if you intend to invest in syndications, or hire an accountant, financial planner, or real estate consultant who is versed in them.
  10. Investor Returns: Usually there is a Preferred Return, which is paid to investors monthly or quarterly from ongoing operations. It runs 6-10%, with 8% being typical. Anything outside this range should be questioned. Beyond the Preferred Return, there can be additional distributions in which the promoter will probably participate.
  11. The other primary return is the Split, which applies to profits and distributions above the Preferred Return, plus proceeds from any refinancing. These rates can be 80/20, 75/25, even 50/50. They are described in the Offering Circular, and you need to decide if they are acceptable to you.

The Syndicator’s “Flip”

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Enhanced Diligence requires that you research the property’s history. To do this, contact the Customer Service department at a major title company at the location of the property. Ask for “a Property Profile” that has transactions going back 10 years. Usually, this will be provided at no cost. Look it over to see if the promoter already owns the property that they are trying to syndicate. If so, they are trying to do “a Syndicator’s Flip” as their exit strategy from ownership of the property. Usually, they will build in a nice profit for themselves upfront such that the investors pay retail or above. Then, since the promoter has their profit, they usually go on to neglect the syndication. Is this common? Not so much. But it happens, and you need to guard against it. Is it legal? Good question! Don’t bother to find out!

Conclusion

Many syndication investors take the easy path by reading the promoter’s Offering Circular, maybe seeking an advisor’s opinion, then wiring funds or writing a check. This is nowhere near enough! They need to go beyond even “due diligence” to Enhanced Diligence. This article equips investors to do that.
Good Luck! NOTE: The author is available for Enhanced Diligence of Syndications, Turnkeys, Joint Ventures, and other investment acquisitions of most kinds. Compensation is based on an hourly rate.
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Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

He writes and edits copy for Realty411 and REI Wealth Monthly magazines.

Mr. Kellogg is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America – 2019.

Mr. Kellogg is available for consulting about syndication, “turnkey” investments, joint-ventures, and other property purchases nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Helping Hoarders Move On — Kristi Cirtwill Buys Houses that Few Investors Can Handle

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By Bruce Kellogg

What is Hoarding?

The Anxiety and Depression Association of America (ADAA) defines hoarding as “the compulsive purchasing, acquiring, searching, and saving of items that have little or no value. The behavior usually has harmful effects—emotional, physical, social, financial, and even legal—for the hoarder and their family members.”
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Different types of hoarders include: 1) Shopaholics 2) Collectors 3) Hoarders of Books or Information 4) Larder Hoarding (hoarding of Food) 5) Animal Hoarding 6) Syllogomania (Hoarding of Trash/Garbage) 7) Recyclers Have you met any of these?

Introducing the Helper of Hoarders

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In Southern California, help for hoarders is offered by HoarderHomes.com which buys homes and is owned and operated by Kristi Cirtwill. She has been in business since 2006 in Southern California, and in Toronto, Canada prior to that. Her specialty is buying houses that need tender loving care. Kristi realized the need for this type of business when she saw people struggling to sell their homes in the traditional way because of the deferred maintenance and the needed repairs. Kristi can buy houses and close in one week, and it doesn’t matter how much work the house needs. She enjoys helping people, and she knows she can turn what would be a difficult situation into a very easy one for the seller. Hoarder Homes also donates to charity and recycles whenever possible.

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Kristi is in this business because she discovered she “had a knack.” She’s not formally educated in real estate except for reading Rich Dad, Poor Dad, joining free clubs, and becoming a licensed real estate agent. She says, “Life can be hard. I choose to be happy.” Also, “I love making money, but I also like helping others.” This includes sponsoring people for citizenship through her company, she says.

Service Areas

Hoarder Homes serves much of Southern California, primarily Los Angeles County, secondly Orange County, then reaching out to Kern, Ventura, Riverside, San Bernardino, and San Diego counties.
7325 Kyle St, Tujunga, CA 91042 MLS-32

Other Issues That Qualify

Besides hoarding, Hoarder Homes accepts homes with a variety of other issues. Here are some of them. 1) Building code violations 2) “red tagged” (“Stop Work” notice) 3) Facing foreclosure 4) Fire/water/mold damage 5) Divorce 6) Drug dealing 7) Squatters 8) Animal hoarding 9) Biohazard homes 10) Natural death on the premises
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With all this variety, Kristi clearly knows not just the core but also the periphery of her craft.

Prospecting For Business

When she first arrived here in 2006, Kristi prospected for acquisitions through 2012 using the Multiple Listing Service (MLS) and wholesalers. Since then she uses these additional avenues. a) Business Network International groups (BNI) b) Referrals c) Facebook d) Instagram e) Linkedin f) Newsletters g) E-mail marketing
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She says, “I make an effort to stay in touch with everybody. When these properties become available, I can move fast!”

A Recent Change

With prices constantly rising since 2009, and the availability of houses shrinking all this time, Kristi has become more conservative. She says, “I want multiple exits now.” Smart lady!
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Bruce Kellogg

Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

He writes and edits copy for Realty411 and REI Wealth Monthly magazines.

Mr. Kellogg is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America – 2019.

Mr. Kellogg is available for consulting about syndication, “turnkey” investments, joint-ventures, and other property purchases nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.

Interview with a Distance Investor

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By Bruce Kellogg

Introducing Bruce Dinger

Bruce-HeadShot--610x869 Bruce Dinger is a long-time resident of Silicon Valley who earned an MBA degree in International Business from Regis University in 1997. Since then, he has spent 30 years as an investor, as well as an educator teaching those interested in becoming an investor. At the present time he has:

1) Completed over 200 real estate projects in the past 32 months all across the world.
2) Runs a hedge fund catering to ultra-wealthy clients.
3) Runs an educational practice that provides education related to investment financial literacy.
4) Serves as an angel investor and invests in technology-based start-up companies.

Here we will discuss his real estate investing at a distance.

Investing Philosophy

Bruce starts by explaining that in order to succeed in investing and, actually in life, it is necessary to “live in a world of abundance, not one of scarcity.” For everyone, including for himself, the best approach to self-optimization is to “invest in yourself.”

When it comes to real estate investing, Bruce is “ZIP code agnostic”. He invests based on potential cash flow wherever it is to be found. To him, “It’s a numbers game.” It’s also a long-term endeavor, “not a sprint, but a marathon.” He says,

“Anything can happen in a deal, so it’s important to buy right.” You “manage risk by buying right.”

Investing Practices

Bruce prospects for properties across the entire country with an in-house team and submissions by potential joint venture partners. His criteria includes: 1) liquid markets, 2) pre-foreclosures, 3) high-equity, absentee owners, and 4) quality school systems, among others. He maintains that he often does not see the properties he purchases. He will only go out to properties to help educate his children about the power of investing.

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Much of the time, Bruce collaborates with brokers and agents. Here, he insists on working with the best. These he selects based on their sales production awards and the number of sales they have closed in the past 24 months. As with himself, his standards are high.

A key element in Bruce’s investing model is to partner in joint ventures to create “boots on the ground” in each area. Some of these partners have no experience in which case Bruce educates them. He has created documents for every step of the system they use, which he calls “McDonaldsalizing” his system!

Bruce usually funds the project, often with money he has raised. Many of his projects sell before he is even finished with them, a benefit from choosing liquid markets. He states that if you buy right, it makes it very difficult to lose money on a deal.

The “Elite Real Estate Investing System”

Besides creating joint ventures with partners, Bruce coaches real estate investing students. He hand-selects students based on their desire to learn the real estate investing business. Not everyone qualifies. He is looking for students that not only want to learn how to build a real estate practice, but students that he can eventually treat as peers and do joint ventures together.

More Than Just a Real Estate Investing Business

Bruce has a huge passion for investing in real estate. He says it is not his love for real estate itself, but for what real estate allows him to do, which is to spend time with his family and do the things he wants to do.

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People often ask how to get into the business of real estate investing. Bruce says, “Easy. Have a passion for life. Be willing to do whatever it takes to get to where you want to go. And hire a Mentor that can get you there.”

Bruce is always looking for the right person to mentor in the game of REI. If you think you have what it takes, feel free to reach out to Bruce – [email protected].

BRUCE KELLOGG

Bruce-Kellogg-300x300Bruce Kellogg has been a Realtor® and investor for 40 years. He has transacted about 800 properties in 12 California counties. These include 1-4 units, 5+ apartments, offices, mixed-use buildings, land, lots, mobile homes, cabins, and churches.

He writes and edits copy for Realty411 and REI Wealth Monthly magazines.

Mr. Kellogg is a recipient of an Albert Nelson Marquis Lifetime Achievement Award, listed in Who’s Who in America – 2019.

Mr. Kellogg is available for consulting about syndication, “turnkey” investments, joint-ventures, and other property purchases nationally, and other consulting assignments. Reach him at [email protected], or (408) 489-0131.