The Real Estate Game
By Jave27 in Culture
Wed Sep 08, 2004 at 08:51:45 AM EST
Tags: etc (all tags)
Some of you have purchased homes before, so you know a bit about how the process works: Mortgage Approval, Appraisals, Surveys, Title Searches, Purchase Agreements, Stipulation Sheets, Closing, Whining, Bickering, Signing 1,000,000 pages, Moving, blah blah blah...
Even though it's a scary thought when you first start, and you've probably heard enough horror stories to not want to go through the process, it's really not that bad. It's actually pretty easy if you take a little time and learn about it. It makes more sense than most college curricula, and it doesn't take a genius to figure it out. Literally anyone can play the game if they have a dedication to making things happen. This is an introduction to real estate investing using my 4 years of personal experience as a guide. While all of my experience has been on the U.S. side of the pond, I'm sure enough of this information will apply to everyone to make it worthwhile. (This was originally submitted as a diary at the other site)
Just so you don't think I'm a hack, a troll, a clueless newbie, etc., I'll give you a little background. I purchased my first house when I was 20. I rented out 3 of the rooms to friends of mine, and all of us attended college. One of my roommates and I decided to start a business, but we just couldn't decide on what to do. I worked full-time for a property management company (company that manages apartment complexes), and I was the IT guy. My roommate worked for a mortgage brokerage (a company that gets wholesale rates on mortgages from larger mortgage companies and sells them to people, taking their cut each time). One of our other roommate's moms was a real estate agent. So, taking all of that information together, it seemed like real estate was a good field to get into.
We started an LLC (Limited Liability Company - like a Corporation as far as liability is concerned, but taxed like a Partnership) in 2001, and bought our first 3-unit house a few months later using a mortgage obtained from his company. Since then, we've bought 11 more houses and sold 3. We've focused on rehabbing and rental property, and would like to eventually move into commercial property and development.
Reasons for Investing
Starting a Company
- Investing is not for everyone. It takes dedication, a will to succeed, a little bit of time (compared to a normal 'job'), and the guts to just get out there and do it. I decided to do this because I don't like working that much. It's not that I don't enjoy my job; I just don't enjoy the idea of having to get up early for the next 40 years if I don't want to. Being able to set my own schedule is enough of a reason to make me focus on this now instead of wishing I had later in life. My roommate/business partner is 25 years old, and he no longer has a "real job". All he does is find houses, hire people to fix them up, rent them out, and sell them. He's not exactly retired yet, but it's a much better situation than a full time job.
- If you are renting right now and you plan on being in the area for at least a year or two, you're throwing your money away. Yes, you have more responsibilities if you own a house, but you can hire people to come and fix things, mow lawns, trim shrubs, etc. In the end, if you do everything right, you'll make money during the time you live in your own home versus spending your hard earned money every month and getting nothing for it in the end.
- The profit margin can be huge. If you're willing to do some research into your market, you can easily find homes selling $20,000 - $100,000 less than what they're worth. There are always motivated sellers, and if you are diligent in your research, you'll find them.
- It's so easy. Compared to a normal 40+ hours per week job, real estate investing is a cakewalk. You'll put a lot of time into it in the beginning, but later, you can sit back for a few weeks, do nothing, and still make money.
- Tax Advantages. There are all types of tax breaks for investors and homeowners that don't exist if you just work a normal full time job or rent. Check with your locale, but I've saved all kinds of money in taxes just because I can write off so many normal activities as business expenses. There are tons of books on this subject, too, so I'll leave it for another time.
Technically, in the U.S., you don't need to start a company to be an investor, but it helps. It gives you better tax advantages, protects you from most forms of liability in case someone sues you for something, and makes you seem more professional. You can say, "Hi, I'm Jave27 from Housing Investors, Inc." instead of, "Hi, I'm Jave27, some random guy next door that wants to buy your house."
Types of companies differ from state to state, but you definitely want to start something that protects you from personal liability. An LLC, an S-Corporation, or a C-Corporation are accepted in most, if not all, states. If you want to take on partners, you should decide that early on. It's usually easier to start a company with everyone involved in the beginning than to add someone into the mix later.
Call around to different law offices in the area and try to find a good real estate attorney. While you can set up the paper on your own with a little research, it's highly suggested that you just go ahead and do it correctly in the beginning so you don't miss anything that hurts you in the future.
Ways to Obtain Financing
You somehow need to be able to come up with $50,000 - $200,000 to buy your first home. While this may sound like a lot of money, it's really not too bad. You'll find that getting most financing will be easiest if you have a job, have a decent credit history, and don't have a lot of outstanding consumer debt. However, even if you don't fit that profile, there are other ways to buy property. The credit score process is an entirely separate conversation, but you can learn almost all you need to know from these sites:
TransUnion, Experian, Equifax
Those are the three largest and most used credit reporting agencies in the world. They have tons of information for you to peruse. Now, on to types of financing (disclaimer: all of the details of these types differ state by state, so this is just a broad overview of what's available)
The best advice I can give you in regards to financing is to make your payments on time and in full. To some people, this may sound like a no-brainer, but even a single late payment over 30 days can be a detriment to your credit score for years. This includes credit cards, lines of credit, mortgages, etc. Just make all of your payments on time, even if you have to borrow money from other sources to do so.
- Conventional Mortgages. This is the process of walking to a brokerage or a bank and saying, "I'd like to buy a house. How can you help?" This is the most common method that people use to purchase homes. If you're doing this to become a serious investor, I recommend finding a mortgage broker that deals primarily with investment property. Let him or her know that you want to purchase a lot of property with little to no money down. You need your cash for other things, not to sink into that magical void we call "home equity". There are plenty of 100% financing programs available in the States, and I'm sure elsewhere, too. In fact, I recently found a local company that can provide financing for 100% of the after-repair value of a home so that you can do all of your rehab work with borrowed money, and only pay the interest on the loan while you have it. These things are out there, it just takes a bit of digging and networking to find them. If you fail to make your mortgage payment, the bank can foreclose on the house and if you fail to act within the legal amount of time (usually 6-9 months), the house gets sold to the bank and you lose your investment.
- Land Contracts/Purchase Money Mortgages. This is when a seller is willing to let you purchase your home from them on a monthly instalment basis. They have decided that they don't need all of the cash on their home right away, so they'll allow you to pay them monthly just as you would a bank if you had a mortgage payment. Typically, they want some money up front as a down payment, and the interest rates are negotiable (usually with a state-mandated maximum percentage). In this situation, you get the title to the house, but they still have an interest in it, so if you fail to make a payment, they can foreclose on you just like a bank can. Then, they get the house back and you lose your investment.
- Assumable Mortgages. These are much more rare to find nowadays. Most new mortgages have a clause that reads "You cannot transfer this mortgage to another party. If you do, we will hold you responsible for the full amount immediately, else you face foreclosure." FHA and VA loans from the 1970's and early 1980's didn't have this clause, so you can sometimes find a mortgage that can be transferred to you by the seller. You can negotiate with the seller for the remainder of the sales price, possibly by paying them monthly as well. Then, you'd have a mortgage and a monthly payment to the seller. Many investment "gurus" such as Carleton Sheets (who you've probably seen on late-night infomercials) advocate this method, even though it's so much tougher to do now than it was when they first started.
- Land Trusts (newer concept, not available in all states). This is a very lengthy discussion, but here's a synopsis: The seller places their home into a revocable living trust (like a trust fund, but designed for real estate - check with lawyers in your state for details). Then, the seller assigns you 90% interest in the trust, plus gives the trustee the Power of Attorney to make decisions about that particular property for him or her. Then, you can make payments on the seller's existing mortgage, and you have full control over this property. Basically, it allows any mortgage to be assumable, regardless of the clause mentioned above. This can become tricky because not a whole lot of people know about it, so many people are afraid of trusts. However, it is 100% legal in the U.S., assuming you have all of your paperwork completed properly. Either way, it's a useful tool to have in your arsenal as you further your real estate career. We've bought one property using a trust, and sold two so far.
- Cash. Obviously, if you have enough cash to purchase an entire property, you can do so. Unless you have enough to purchase multiple properties simultaneously, I would recommend against it. Cash is better used as down payments or to make improvements with. For example, if you have $50,000 cash, you could buy a cheap home. Or, you could use mortgages and put 10% down ($5,000) on 10 cheap homes. Or, you could put 10% down on 5 homes, and still have $25,000 to use for improvements that result in your homes being worth more money. If you plan on being a serious investor, equity in properties that isn't being used to buy more properties or otherwise make more money is useless.
This is where you should find a knowledgeable, experienced real estate agent who has been in the area for a while. He or she should be able to spot good deals for you as they come onto the market. It's good if you find someone who deals with investors, too. Most agents just try to match what their one-time client is looking for to what their little database of properties says is available. You want someone that has a good listing record for when you sell and also knows how to search the database quickly and efficiently (commonly called an MLS - Multiple Listing Service).
There are tons of avenues to travel when making money in real estate, but some of the most profitable are in development and rehabbing. For rehabbing, you want to find run-down properties in nice neighborhoods. A lot of times, these properties are bank repos, and you can get them at a steep discount. Many localities have Internet-accessible assessors' pages so you can look up information on any property in the area. These will include square footage, recent sales information, pictures, tax information, who the owner is, and all types of historical data about the house. Your real estate agent will know how to access this information if you don't. Or, you can go down to the county courthouse and look it all up in their filing cabinets. This is one way to determine what the going rates are for homes in a given neighborhood. Just look up all recent sales within a quarter mile of that home and compare those homes to the one you're looking at.
Look at a LOT of property before you purchase anything. After looking at ten or more homes, you'll start to get a feel for how much things cost and be able to see different neighborhoods in your area. Once you find something, and you're ready to go, write an offer. Unless the asking price is unbelievably cheap, don't be afraid to place an offer much less than that. I've offered $80,000 on a $105,000 property and got it. I've heard of people making even larger spreads than that, so anything is possible. Also, don't be afraid to make a bunch of low-ball offers at the same time. It's kind of like fishing, you never know when you'll get a bite.
"Ok, I've got a property, now what?"
Do you want to rent it out, rehab it, or just try to resell it quickly (called flipping) for a profit? Like I said earlier, there are lots of avenues, you just need to pick one (or more). If you think you can make enough money renting, go for it. Here are few rental tips:
If you're going to rehab, I recommend being there a lot during the first one so you know what to expect from contractors. You'll probably go through a ton of contractors before you find a few that you really like and want to work with. Don't do anything yourself. If you do, you limit yourself as to how many of these projects you can take on at once. Plus, unless you're a professional, it probably won't be as good of a job. It's good to be there and learn how hard or how easy everything is, but don't attempt to fully rehab a house by yourself. It's not as easy as the TV shows make it out to be.
- Don't accept late payments. I don't care what their situation is, don't do it. I've been burned EVERY SINGLE TIME I've let people slide on rent. If their rent is due on the 1st and you don't get it, send them an eviction notice on the 2nd. That doesn't mean that you have to evict them, it just shows them that you're serious, and just in case you do have to evict, you're one step closer in the court system. Most states give them 3-10 days to pay up after you send the notice, otherwise you can file in court and remove them within a reasonable amount of time.
- Don't bend to their every whim. If they want a new fridge or stove because theirs is ugly, say no. Tell them they get charged every time you send out a maintenance person to fix something they broke. You can be nice, but still be firm that you are the landlord, not them.
- Don't let anything sit vacant long. Vacancy is the #1 killer of profit. If you can't fill the unit for 2 months, you still have to pay the mortgage, but you have no income to support it. That just hurts.
- SCREEN YOUR APPLICANTS. Do a credit report and possibly a criminal report before renting to anyone. Get a copy of their state IDs, as well as their social security number (or equivalent for non-USians). Make sure they aren't moving because they just got evicted from their last home.
- Check with local low-income government agencies. There are lots of programs that provide subsidies for families with low income. They may have a list of qualified tenants waiting for a place to live, and your rent will be guaranteed by the government. Depending on your area and what type of home you have, you may be able to keep it fully occupied and always have money coming in. Take advantage of that if you can.
Get permits for any major structural changes, plumbing, electrical, or gas pipes. If you don't do it legally and something bad happens, you're in a lot of trouble. Better safe than sorry in this instance.
To find money for rehab work, try to get lines of credit tied to the home's equity. Those usually have lower interest rates than using credit cards or personal lines of credit. I've put very little of my own out-of-pocket cash into my investing, and I should be getting all of it back as soon as our next property sells. Companies really like to hand out money as long as you have shown that you can make payments.
You have to be very creative to make some deals happen. It's good if you have a creative mortgage broker who can structure programs to suit your situation. It's also good to have "flexible" appraisers who don't mind stretching values a bit to make deals happen. Don't break any laws, but find people that are willing to work with you for everyone's benefit. When dealing with people, make sure they know that if everything goes smoothly, you'll be utilizing their services again very soon.
Remember, when you buy someone's home, you're trying to get a deal yourself, but you're also trying to solve their problem. They want to sell for a reason. Find out what that reason is, and see if you can structure a plan with them to make everyone happy. Land Trusts are good options if you can explain them correctly. They don't show up on your personal credit report, plus they protect the seller in the event that you don't make the payments more than a Land Contract would. Just be flexible, and a lot of deals will come your way. The "Deal of the Century" comes around about once a week if you keep your eyes open.
"Ok, decent overview, how do I really get started?"
- Find a local investors group. You may have to drive into a larger nearby town, but do it. Find some people you can network with to get the ball rolling.
- Read a book or two. Go to your local bookstore and pick out something that seems up your alley and fits your interest level. Even if you decide against doing it, it will give you a better understanding of the process and the game.
- Check out investor sites online. My favorite is CRE Online (Creative Real Estate Online). Check out their forums. You could spend a month reading the HOWTO and Success Story articles, and then you could spend years reading the forums. They are very active forums and very experienced investors participate in the discussions. A lot of them are trying to peddle their "Patented Money Making Systems(TM)", but those aren't all bad, either. But, there's enough free information to overload you pretty quickly.
Obviously, there's a lot more to this that what I've written here, but most of what we've learned has been along the way. You're not going to know everything when you start, and ten years from now, you still won't know it all. But, it's better to regret doing something than nothing at all. If you really want to attempt to start your own business and retire early, real estate is a game that everyone can play. The rewards greatly outweigh the risks, in my opinion, and many people I know can attest to that. If you decide to venture into this field, good luck, and let us all know about it!