For all of the complexities, theory, strategies, logistics, tactics, execution and practices that surround real estate investing, there remain but two very simple rules:
“Rule Number One: Never lose money.
Rule Number Two: Never forget rule Number One.”
- identify your investment strategy
- build a network of help
- select properties that have underlying value drivers
- know your governmental restrictions and requirements
- gather and review reports, inspections, and disclosures
- inspect the property and meet the tenants
- underestimate the process of due diligence
- underestimate the required operating expenses
- get emotionally involved
- let your rent levels fall below market value
- employ your tenants
Clearly identify what you are trying to accomplish: Cash flow for present lifestyle or for retirement? Equity appreciation rather than cash flow that can be currently taxed at a high rate? Building your legacy for family? Immediate, interim or future tax shelter?
Is this a long-term or short-term hold? Is your plan to buy and flip this property when the marketplace changes? Will this be a retirement home?
For the sake of what you are investing in, what is the lost opportunity cost to you?
Build an accomplished a network of strategic and tactical help that is impeccable in their execution and timely in their delivery.
Partners must include: a CPA or tax attorney accomplished in your local area and possible asset class real estate brokerage skilled in working with a collaborative partnership mortgage financing, property management, trust attorney not a “captive” insurance advisor but an independent broker.
Wise investing with optimal returns now demand collaboration across complimentary disciplines.
Value drivers will contribute to long-term rental and purchase desirability.
Proximity to employment campuses, top rated schools and universities, airports, medical campuses, sports stadiums, and transportation systems, built or to be built is conducive to securing quality tenants who increase the value of the investment. Researching and understanding future plans for the considered area will impact strategies and return on investments.
Locate “pockets” of multi-family investments surrounded by single family homes. These pockets will attract quality people increasing the demand. An increase in demand with a limited supply increases the leasing price and stabilizes the turn-over-producing an optimal return on investment.
Few private investors understand the present and future governmental restrictions and requirements. Institutional investors, however, use governmental restrictions and requirements as part of their investment strategy in order to optimize their return on investment.
Imagine the impact or benefit of:
- rent control restrictions
- below market housing requirements (BMR)
- mandatory participation in city-run property management programs
- eminent domain
- capital gains increase, decrease, elimination
To do this, you need to make sure you cover your basis. Keep these in mind specifically:
- Obtain tenant signed estoppel certificates for all tenants.
- Review investment financial statements with skepticism.
- Review tax returns with pragmatism.
- Review all leases.
- Obtain full inspections: roof, HVAC, termite, property, chimney, prelim, pool.
There are many thing you can do when you inspect a property for yourself. Here are some things that you should make sure not to miss:
- Ask questions about their assessment of the property, owners/management company’s management and maintenance style.
- Speak to the tenants in the adjacent buildings.
- Check police reports.
- Contact previous owners or other owners in the area.
This is where most investment strategies go astray-producing less than optimal returns and a negative outcome. Remain centered, pragmatic, unyielding and skeptical.
Never rely on the sellers or brokers operating expenses, guarantee of rents, statement of improvements (with or without receipts) market assessment, cash on cash return on investment, cash on return (factoring in the building of equity), capitalization rate (CAP) or gross rent multiplier. These often reflect the current owner’s income and expense not the new owner’s income and expense.
Confirm the factors used to calculate these metrics:
- Whose property tax base is being used?
- Who is managing the property?
- What maintenance has been deferred allowing for positive metric for the sale?
- Is the insurance coverage under quoted?
- Is there an onsite manager and what are they paid?
Overestimate expenses and reserves required and underestimate anticipated revenue when assessing anticipated cash flow. Identify the large capital improvement projects for the coming years, and allocate a monthly reserve in anticipation of these repairs and capital projects.
Some large operating expenses that can challenge the success of an investment include:
- roof with a four-year life expectancy
- galvanized pipes in an investment over 35 years of age
- major operating systems such as water heaters
- pool refinishing
- concrete repair or replacement
- garage door or carport repair or maintenance
Emotional strength and centered, well-grounded assessments are a requirement for all investors. Once you have defined your balcony strategy, do not let emotional short-term influences impact your decisions. As much curb and metric appeal as an investment may have if it does not meet or continue to meet your investment strategy, move on.
Not enough emphasis can be placed on this practice, particularly in rent control areas. It is very common for owners and managers to want to minimize the turnover of their investments by keeping their rents low. They often state proudly that they maintain a low vacancy rate.
Rather than a benefit, this strategy creates breakdowns. It makes raising rents challenging for a new owner. Tenants who have enjoyed low rents for years reject any large increases and often move with resistance and delays, leaving an aged vacant unit that will require money to rehab before releasing. To prevent a mass exit, a new investor has to spread out the rent increases for the units over a long period of time. If there is rent control it can be years if not decades. This is a huge burden to an investor.
In addition, the overall value of the investment remains challenging for lending purposes, maintenance and re-sale. Consider the following:
- Building A – Gross annual rents of $120,000 with a gross rent multiplier of 10.5 for the area makes the building value $1,260,000. ($120,000 x 10.5 percent)
- Building B – Gross annual rents of $95,000 with a gross rent multiplier of 10.5 for the area makes the building value $997.500 ($95,000 x 10.5 percent)
If two businesses were offered for sale at the same price and one had gross revenues 21 percent higher than the other which would you choose?
This is an absolute don’t. Do not allow tenants to do work on the property and especially in exchange for discounted rent. It is so innocent yet with so much exposure to the owner/manager.
Imagine a call regarding the following:
- smoke detector is beeping, the batteries are out
- the garbage disposal is leaking
- a light in the foyer is out
- the hinge on the side gate is broker
- the screen on the sliding glass door is torn
- maintenance person neglected to place the garbage receptacle on the street
A tenant performing any work for compensation creates an employer/employee relationship with the resulting requirements for reporting and providing the appropriate withholding, W-2’s/1099’s and workers compensation coverage. If the tenant incurs any injury during the course of performing activities on behalf of the owner this can expose the owner to serious liability.
In order to mitigate threats and capitalize on opportunities it is essential to have a well-grounded investment strategy. This includes the collaboration of complimentary disciplines and fastidious attention to every detail of execution including strategic, tactical and logistic details. The devil is always in the details.