A real estate investor’s own personal finances can play a big role in managing profitable real estate investments. One of the biggest mistakes anxious investors make is to take on a lot of leverage and financial risk with rental properties when their own finances are in shambles. Having your own finances in order is important to your real estate investments for at least three reasons: (1) you may need cash or available credit to address a major repair to the property; (2) you need to able to weather prolonged vacancies or non-payment of rent, and (3) you want to qualify for the best available financing when you buy or refinance a property.

So here is a quick primer on sound personal finance habits every real estate investor should know.

1. Supercharge your emergency fund: Most personal finance experts recommend keeping three to six months of living expenses in a savings or money market account. For the individual real estate investor, however, this isn’t enough. You should consider how much you would need to keep your properties afloat if rental income wasn’t coming in the door. There’s no magic formula here, but some suggest keeping a year’s worth of expenses (mortgage, taxes, insurance, repairs) for each property. That’s extremely conservative, but the point is that your emergency fund should be above to cover your rental properties for at least three to six months in addition to your own household expenses.

2. Pay EVERYTHING on time: Avoiding late payments on your debts is critical to the real estate investor. Late payments can have a major impact on your credit score, which can result in raising the interest rate you’ll pay for a mortgage on a rental property. In extreme cases, it can even disqualify you for traditional financing, particularly given the tight credit market we’re in now.

3. Maintain available credit: I have available credit on both my home equity line of credit and on a number of low interest credit cards. It’s never my intention to use this credit for real estate investing (except on perhaps a very short term basis), but the available credit is important for at least two reasons. First, having unused, available credit can improve your credit score. Second, it’s nice to have the available credit in the even of an emergency. Of course, you should be relying on an emergency fund when the air conditioning unit goes out, but some extra financial cushion never hurt.

4. Diversify your investments: I know I’ll take some heat on this one, but in my opinion, real estate shouldn’t be one’s only source of investment income. I have a fair amount invested in stocks and bonds. I also invest in REITs. These investments, along with my real estate holdings, provide a nice diversification that reduces the overall risk of my investment portfolio.

5. Shun consumer debt: Many Americans are buried in consumer debt. They use credit cards and home equity lines of credit to a fund a life style they can’t afford. Before long, they are mired in debt and working harder and harder just to stay afloat. The goal of real estate investing, at least for me, is to achieve some significant degree of financial freedom for me and my family. But I’ll never achieve that if I have consumer debt that is growing each month.

6. Maintain an updated personal net worth statement: It’s a good personal finance habit to know and track your net worth. With real estate investing, it’s doubly important because you’ll need this information when you apply for financing. In addition, a net worth statement will also allow you to see how your real estate empire is growing.

7. Stick with fixed rate mortgages: Particularly if you dabble in variable rate mortgages on some or all of your rental properties, financing your own home with a fixed rate mortgage is critical. Mike and I have financed some properties with variable rate mortgages, at least for a time. These investments expose us to enough interest rate risk; we don’t need to add to it by financing our own homes with variable rate mortgages. Besides, interests are still at historic lows, so with perhaps a few exceptions, there is little reason not to lock in the low rate now.

We could add many more to these, but these are seven of the more important personal finance habits I’ve found helpful to my real estate investments. Perhaps you can add to this list. If so, by all means leave a comment. If you disagree with any of these points, email Mike.

The Mrs. once remarked, “When you and your father get together, you can talk about real estate until there’s no more oxygen left in the room.” Yep, we can get going pretty good. We’ll talk about his properties, my properties, the market, the last deal, the next deal, the tenants, the banks, and, if Rob’s in town, we’ll occasionally break for cards.

This morning, my father and I were doing our best to deplete breathable air, on this occasion, via phone. The conversation began when he called to ask if I had any interest in a Ford Expedition. It seems that he finds himself a bit vehicle-heavy as a result of his latest real estate deal. He had a double that he was looking to sell in an area that required a bit more management than my father was interested in continuing to provide and was approached by a newer investor that didn’t mind the time and effort. The newer investor was looking to buy but was shy on cash. He did, however, have this car that he was looking to sell. So, my father came down some on price, the investor came up some, and the Expedition bridged the gap.

Sometimes, real estate investors can find their best deals, buying or selling, by using a little creativity. While the Ford Expedition may not be on the lot in every deal (nor would you want it to be), considering options other than just money changing hands at the closing table opens up possibilities. As a fellow real estate investor recently considered, alternative financing may frequently provide the mechanism to make the deal work for buyer and seller. Particularly at times like these when banks seem to be forgetting that they are in the business of lending money, the real estate investor has to be open to other possibilities. Consider lending money to your buyer, borrowing from your seller, providing a purchase option for your tenant, taking a property in trade, or maybe even taking that for-sale vehicle off your buyer’s hands.

My father’s real estate dealings over the years, besides being fodder for wisecracks, certainly serve as my reminder to watch for opportunities to create the deal, and a good real estate investor sometimes has to find those opportunities for both sides. So, in the spirit of inspiring the deal and just for a little fun, I thought I’d share some of my father’s more creative side purchases over the years that made the deal. Over more years than I care to admit, here are the “side purchases” that stick out in my memory:

a 1974 Volkswagen beetle
a 1975 Buick Riviera
5 acres of undeveloped land in Maine
a plot of desert property in New Mexico
some swamp land in Florida
an antique (here, insert “old”) desk
office furniture
labor on the rehab
10 asphalt driveways

Image Credit: Daquella manera

In the previous article in this series, I looked at factors to consider when deciding whether and to what extent a real estate investor should remodel a kitchen. With our property, No Basement, Mike and I decided to completely renovate the kitchen using a budget of just $4,000. In this article, I’ll be writing about the next step: design and materials selection.

Designing an Inexpensive Kitchen Remodel

It is in the design phase that many investors go wrong. The wrong design decisions can quickly add thousands of dollars to a project both in material and labor costs. They can also delay the rehab process if they add additional inspection requirements to the project. So we follow some basic rules of thumb when designing a new kitchen:

Rule #1: Never move a load-bearing wall unless there is no other option. To this I should add Rule #1.5—there is almost always another option. Moving load bearing walls, and particularly exterior walls, require the services of an engineer during the design phase and additional inspections by your local government. Professional fees, inspections, and construction costs to move a load-bearing wall could break the bank and delay the project by weeks, if not months. On a $4,000 budget, it’s not an option.

Rule #2: Stick to the original kitchen layout as much as reasonably possible. This is not the time to be creative. If the original kitchen layout works reasonably well, keep it. Any substantial redesign in the layout will almost certainly mean re-routing plumbing and electrical. Keeping the existing layout will save time during the design phase and will reduce complexity and costs of the project.

Rule #3: Use as much of the existing kitchen as you can. In No Basement, Mike and I considered keeping the original floor. In the end, we replaced it, but it was a close call. If you can design the new kitchen in a way that allows you to keep parts of the old kitchen, you can save even more money.

Rule #4: Improve functionality in the cabinet configuration. While the overall kitchen layout will likely stay the same, there’s always some room to change the cabinet configuration. We’ve seen numerous builder designs and bad remodels that don’t make sensible use of the existing space. Home-improvement retailers typically offer free design assistance. You’ll need the kitchen measurements and a quick crash course on standard cabinet sizes, but then you can change up the cabinet configuration pretty easily. Here are a couple of quick ideas. Make sure there’s a drawer set. Builders somehow manage to skip this on homes with some regularity. Change out a blind corner to an easier access lazy-susan. Consider a tall pantry cabinet when the kitchen doesn’t have a closet-style pantry built in. And here’s one we used for No Basement. The kitchen is an L-shape, which generally means a dead space at the corner. We flipped the direction of a cabinet at the corner to add some extra storage and used a wider counter-top that created a breakfast bar. Kitchens sell. A more functional cabinet configuration within the existing layout will help bring buyers and keep tenants.

Picking Inexpensive Yet Durable Materials

Once you’ve chosen the layout of your new kitchen, selecting the right materials is critical to staying within your budget. The four major costs to most kitchen remodels are cabinets, appliances, flooring and labor. We’ll leave the labor part for now, but here’s how we choose the materials.

Cabinets: When Mike and I tackled the first kitchen remodel, I was totally unaware of how inexpensive good quality cabinets can be. We buy pre-finished, stock cabinets, typically from Lowe’s. These cabinets come off the shelf, ready for installation by our contractor. We have a commercial 30-day account at Lowe’s that gives us a 10% discount on most purchases, including cabinets and about everything else we’ll need in the kitchen. The cabinets look good, are durable, and inexpensive.

Appliances: We provide appliances in all of our rental units. It seems odd to me that somebody would rent a single family home without appliances, but I know landlords who still don’t provide them. The market dictates the rule here. In our area, renters of single-family homes sometimes furnish their own refrigerator and stove, but the market is trending towards all kitchen appliances coming with the home. If you really want to “design on a dime,” 86 the fridge and stove, and offer to provide them as an option, with an additional rent charge. As a built-in appliance, a dishwasher is pretty much standard either way, but also the least expensive of the set. We provide a full appliance set in all of our homes with the idea that it completes the overall visual picture and helps bring the renters, and higher rents, that much quicker.

We buy our appliances from a local discount appliance store. (Even with the discount, Lowe’s doesn’t always hit the price point on appliances). We’re happy with the floor model if it’s in good shape, and it saves us even more money. We still stick with the recognized brands, and we’re looking to beat builder grade. For No Basement we bought stainless appliances for just a few extra bucks over the standard plain-jane white.

Flooring: Here we splurged and imported marble tiles from Italy. Well that was my idea, but Mike chose instead to import some vinyl flooring from a local flooring store. He has no imagination. But it turns out that he can pick some of the finest linoleum in the tri-state area. The flooring tends toward the neutral, but is a cut above builder grade and actually looks good. Ceramic tile is an option. It may win on durability but probably not, even in the long-run, on cost.

In the third and final article, I’ll discuss how we select a contractor, sum up the costs of the project, and suggest a few inexpensive ways to set the kitchen apart from the competition. I’ll also show you some pictures of the finished product at No Basement. Until then, if you’ve renovated a kitchen, drop us a comment about your project. Better still, send in some pictures, and we’ll include them in the next article.

Photo Credit: onebyjude

When Mike and I first began investing in real estate, the thought of undertaking a major rehab was overwhelming to me. We had spent a weekend looking at potential investments, many of which needed substantial repairs. In fact, one of the properties reminded me of the basement in Silence of the Lambs. We didn’t buy that one, thankfully. But one of our first properties (No Basement) did require a complete kitchen remodel. I remember thinking that it would cost us $10,000 to $20,000 to remodel the kitchen, and I was shocked when Mike told me we could get the job done for under $4,000.

I’m going to tell you how we (well, really just Mike) managed to gut a kitchen and install new flooring, cabinets, counter tops, sink and appliances for under $4,000. And to be clear, we didn’t do any of the work ourselves other than snap a few pictures of the new kitchen, which I’ll show you at the end of this series.

Today, I’m going to look at factors we consider in deciding whether and to what extent we should remodel a kitchen.

Should a Real Estate Investor Remodel the Kitchen?

One of the first questions Mike and I ask when looking at a potential rental property is whether and to what extent the kitchen needs to be remodeled. In some cases, the answer is obvious. We looked at one HUD foreclosure that literally had a kitchen that was nothing but walls. The previous owners had taken the cabinets, appliances, and well, everything including the kitchen sink, out of the home. Apart from Mike’s momentary thought of just advertising the home as “open and airy,” this was going to need the works.

But we’ve also bought some homes with a kitchen that was close to pristine. The Ranch had a kitchen that needed very little improvement.

With many properties, the kitchen remodel is a judgment call. And we make the decision based on one overriding factor—the return on our investment. While calculating the ROI of a kitchen remodel is as much art as science, we ask the following types of questions:

• Will improvements to the kitchen increase the value of the home by more than the cost of the remodel?
• Will a kitchen remodel enable us to charge higher rent, and if so, by how much?
• Will a kitchen remodel help us rent the property faster?
• Will a kitchen remodel increase the chances of finding a lease-purchase tenant?
• Will a kitchen remodel delay getting the home rent ready?

In other words, is the kitchen going to pay for itself? If the answer to that question is no, we likely won’t be remodeling the kitchen.

In addition to ROI, we also consider how a kitchen remodel will affect our financing. Conventional financing generally limits a real estate investing loan to 80% of the purchase price. But we can obtain financing with a smaller bank (or “portfolio lender”) that allows us to borrow 80% of the improved value of the home. So, if we can buy the home at a discount and rehab the property in a cost-effective way, we can often finance 100% of the cost. In the case of No Basement, we came out of pocket about $2,000 on a property that cost us, including rehab, about $102,000. Without the kitchen remodel, we would have had a lower appraisal and likely would have had to invest more of our cash.

In the case of No Basement, the decision to remodel the kitchen was a close call. The home was 15 years old. The kitchen showed some age and wear, but it was still livable. The cabinets were cheap, but functional and, importantly, actually present. The tile flooring had a few cracked tiles and a funky color, but we could have replaced the cracked tiles by re-using some of the tile that we were removing between the kitchen and dining area where we would be putting in carpet. But in the end, we decided on a full kitchen remodel. We did so for four reasons: (1) if we put it off, we would likely only be delaying the inevitable, as it would need to be remodeled in the foreseeable future; (2) we believed that a remodeled kitchen would allow us to charge about $50 more per month more for rent; (3) a remodeled kitchen would help attract a lease-purchase tenant; and (4) we concluded that a remodeled kitchen at a cost of under $4,000 would increase the property by more than the cost.

It’s worth noting that our first tenants at No Basement did not sign up for the lease-purchase. But two years later, our next new tenants did. Did the kitchen make the difference? It’s impossible to know for sure, but I think it did.

Once you decide that something needs to be done to the kitchen, the next question is what. I’ll cover this question is my next post.

Finding rental properties for the right price is one of the most important aspects of real estate investing. The old adage is true. You make money when you buy. The price you pay for a property will dictate profits.

Foreclosed properties present buying opportunities for investors. While we’ve provided several online sources for finding foreclosure listings, most sources are seller sites, such as larger lenders and HUD. RealtyTrac offers a service that provides some advantages for the investor searching for value properties over individual seller sites.

About RealtyTrac

RealtyTrac describes itself as “the leading online marketplace for foreclosure properties” and publisher of “the country’s largest, most comprehensive foreclosure database, with over 900,000 default, auction and bank-owned homes from across the country.” RealtyTrac collects and organizes foreclosure data from about 2,500 counties in the United States. The data covers more than 94 percent of U.S. households.

RealtyTrac supplies real estate market and foreclosure data to the likes of MSN Real Estate, Yahoo! Real Estate, HomeGain.com, Homes.com, Earthlink, Living Choices, and The Wall Street Journal’s Real Estate Journal. It also publishes a monthly U.S. Foreclosure Market Report, which has been featured in stories on The CBS Evening News, ABC World News, NBC Nightly News, Money, Time, FOX News, CNN, CNBC, MSNBC, and The Wall Street Journal. The company also publishes a quarterly and annual recap of foreclosures, and a quarterly report that ranks the top 100 metropolitan areas by their foreclosure rates.

Advantages for the Real Estate Investor

The primary advantage of RealtyTrac for the investor is the depth and scope of foreclosure information. By drawing from numerous public and non-public sources, RealtyTrac provides information at various stages in the foreclosure process, from pre-foreclosure, through auction, to post-foreclosure bank owned properties. And the listings collect information across various sellers in a single source. More properties; better deals.

RealtyTrac also provides information to assist the investor in the evaluation process. It collects and provides property values, comparable sales, loan history, tax lien and bankruptcy records, trustee and lender information, and property details.

Searching for real estate foreclosures on RealtyTrac

The search features for RealtyTrac include criteria searching that you might expect, such as geographic searching by city and state or zip code. I generally search by zip code, which returns a list of homes for sale in the following categories:

• Pre-foreclosure listings
• Foreclosure listings
• For Sale By Owner listings
• New Home listings
• Auction listings
• Bank-owned property listings

Searching in a zip code from Virginia where I use to live found 813 properties. Here’s what the start of the search result looks like:

You can see on the far right of the screen shot that RealtyTrac allows you to view the properties on a map or get more details about a specific property. Here’s what the map view looks like:

The Downside and the Decision to Use RealtyTrac

RealtyTrac is a subscription based service, so the downside is one–cost. Fortunately, it offers a 7-day free trial so you can see what they have to offer. You can sign up for the free 7-day trial by clicking here. I’m currently signed up and using RealtyTrac, in part because Mike and I are looking to buy. Once we’ve bought, I’ll likely cancel my subscription until it’s time to buy again (which if Mike has any say in the decision, will be about 12 minutes after closing on our next property). Consider making your own evaluation during the trial period while it’s free, and come back and let us know what you think.

In order to buy a HUD home, your offer has to meet two criteria. First, your offered price has to beat your competition. Second, your offer must meet the super-secret HUD minimum acceptable bid. In this article, I’ll be writing about determining the super-secret HUD minimum acceptable bid. (Let’s just call it the SSHMAB minimum bid). If you haven’t done so, you might want to check out our first two articles on buying HUD homes here and here for some background.

The first criteria is easy enough to understand. The highest bid wins. I mean, HUD’s the government and all, but it isn’t stupid. So, HUD takes the highest bid net of costs, such as realtor commissions and buyer-requested closing costs, provided it’s above the minimum bid.

Why Do I Care What Bid’s Acceptable to HUD?

First, knowing the minimum bid may help you get your best deal. If you’re looking to buy a HUD home, whether you’re an investor or home buyer, you’re obviously looking for a deal. I mean there are plenty of homes out there for sale that have some advantages over HUD homes. Advantages such as heat, smoke alarms that don’t incessantly chirp for lack of working batteries, and the notable absence of big ugly Warning–This property is monitored by electronic surveillance signs. So, assuming that you’re in the price-conscious buyer category, knowing the minimum bid can help you buy a HUD property at the lowest price. While you still may have competition that may drive the price higher, HUD properties often can be purchased at the minimum bid price.

Second, knowing the minimum bid can help you quickly rule out properties that are of no interest. Depending on your area, you may have more than a few HUD homes as potential options–in some areas, quit a bit more. HUD homes, just like other listed homes, have a list price. Armed with the knowledge of the minimum bid, you’ll be able to rule out some of the properties that are overpriced even at the minimum bid.

Third, if you’re looking at HUD homes, and then offering less than the acceptable bid, you’ll be wasting your time. You can do this all day long if you like making offers, but HUD won’t accept them. This is the corollary to “HUD is government, but it isn’t stupid”. Because HUD is government, it isn’t flexible. HUD will not evaluate your offer, take a look at the property, maybe reappraise it, counter, and then negotiate. It (or at least the private companies that manage HUD properties) has a nice impersonal set of rules rigidly followed with predictable results. Well, predictable within a range.

Determining the Minimum Acceptable Bid

I would love to be able to give you the formula that, once applied to the list price for the HUD home you want to buy, will spit out the minimum bid. Unfortunately, I can’t. The reason I can’t is because (1) the minimum bid calculation is different in different states or regions and (2) it changes, albeit slowly, over time. I might be able to determine all formulas for minimum bids for all HUD regions as of today, but that would take me many, many, many hours and after I got done one or more of the areas would change.

What I can do is give you the exact formula that HUD applied to the sales of HUD homes over the time that I have been buying right up to Rob and my purchases of HUD homes as recently as the Spring of this year. I can also show you how we determined the minimum bid formula and a likely method to determine it for your area.

First, the minimum bid formula was, and is, a percentage of the list price. When I first started buying HUD homes (about 10 years ago), the rule was pretty simple–the minimum bid was 80% of list price. The formula had changed by the time that Rob and I started buying HUD homes (about 2 years ago). It also got a little more complicated. At that time, when a property first hit the HUD list, the minimum bid was 87% of list price. However, the minimum bid dropped to 80% after 60 days.

Which brings us to the second point–the minimum bid is a function of time on the market. When the housing market hit the skids, the HUD minimum bid calculation changed. By the time that Rob and I bought The Loft (click here for the name explanation), the minimum bid for HUD homes was 80% of list price when bids opened. It dropped to 70% after 30 days. There were further drops when a home went unsold for several months, but the number of these homes were so few that it was difficult to calculate exactly. I saw one home that sold at 50% of list price at around 150 days on the market.

So, will this most recent formula work to determine the minimum bid for your area? Maybe, but if not you should be able to determine the formula using this information and the published “bid statistics” for home sales. In a prior HUD article, we took a look at navigating the HUD website to find property information for your area. By navigating to the site for your home state, you’ll see an option for bid statistics. (Click on this link to see the screen shot for Colorado, for example: HUD Bid Statistics). On the HUD homes sites, the private firms managing the HUD sales provide a bid statistics category. The bid statistics page shows all bids, accepted or rejected, on each property for a two-month period. With some effort, you can use the bid statistics page to determine the minimum bid formula for the area over time. The difficulty lies in working with a sufficient number of accepted and rejected bids over months to get a good idea of the minimum bid. However, the information above, along with some patience, should get you there.

A Couple of Final Notes

While I noted that the minimum bid formula changes over time, determining the minimum bid is still likely to be a worthwhile exercise. In the 10 years that I have purchased HUD properties, the minimum bid formula for my area has changed only three times.

Also, you should be aware that when I’ve referred to a formula as a percentage of list price, I am referring to the original list price. After a period of time on the market, HUD will lower the list price, but the lowered price does not seem to correlate with the lowering of the minimum bid. So, in one instance, the list price may not be lowered when the minimum bid has been and vice versa.

In addition, I discovered fairly recently that the management company seems to have some discretion in determining the minimum bid. I came to this conclusion because the minimum bid changed once again after Rob and I bought The Loft, which corresponded with a change in the management company. The minimum bid percentage increased. The increase certainly did not seem to be justified by market conditions. The only thing that had changed was the management company. Given that, I also suspect that the minimum bid calculations when we bought the Loft are likely to be duplicated in other regions where the same management company continues to handle HUD sales. If you want to know to which company I’m referring, drop me an e-mail, and I’ll be happy to pass along the information.

Finally, just because the bid’s acceptable to HUD, doesn’t mean it should be acceptable to you. You’ll need to still make your own determination of value. I’ve found several HUD homes that met my criteria. With the knowledge of HUD’s minimum bid, sometimes I’ve been able to buy homes that meet my criteria and then some.

Happy hunting!

In our last article, I wrote about Gross Rent Multiplier as a quick and dirty method to compare potential real estate investments (plus reasons why it may not work in Canada) and the substantial limitations of using GRM. For the most part, I suggested that GRM be used as a way to quickly sort out investments that are of no interest and those that might be worth further investigation. Of those that merit further investigation, an evaluation using capitalization rates is useful.Capitalization rate will tell you what percentage of the property’s purchase costs you’ll earn back each year. So, the higher the cap rate, the better. It’s calculated as follows:

Breaking it Down–Net Operating Income

OK, the expense part’s a bit daunting, but it’s really not that difficult. One approach is to shortcut the process by using a fixed percentage of gross rents to calculate operating expenses. I’ve seen suggested ranges of operating expenses being anywhere from 30-45% of gross rents. I have to say, I like the idea of shortcutting, but this one, not so much. It kind of defeats the purpose of using capitalization rates to go a little beyond GRM as a method of comparison. If you use a fixed percentage of gross rents, it suggests there is no difference in costs between properties, so you’re right back to one of the limitations of using GRM–that is, not considering operating cost differences between one investment versus another.

And I don’t think this reflects reality. For example, there are differences in operating costs as a percentage of rent between different types of properties–such as single-family homes versus multifamily or older homes versus new ones. Even among similar properties, we are finding significant expense differences right now with property taxes. Due to the wacky prices people have been paying for homes, taxing authorities have been more than happy to jump on the bandwagon and set the tax assessed value of the homes at their most recent sale price. For properties purchased (or, more so, built) over the last three to five years, the tax assessed values have gotten particularly off the beam.

As a result, when we look at potential investments, we’re making a run at calculating actual expenses that we can know up front, such as insurance (get a quote), taxes (mostly available online at sites like this one), and HOA fees (contact the association or heck, ask a neighbor), and using a standard allowance for vacancy and maintenance and repairs. For now, we’re only looking at single-family homes, mostly built within the last 10 years or so, so standardizing vacancy and maintenance costs probably has some validity. Give us a couple more years, and we can all find out how badly we screwed up on repair and maintenance estimates.

Of course, if you’re looking at purchasing investor-owned property, such as multi-family properties, then you can get a statement of historical operating expenses to determine what those are. Then you can get schedules from their tax returns to determine what they really are. Oh, and then you can go through the same process as noted above to determine what they really, truly will be after you buy it.

Breaking it Down–Purchase Costs

Purchase costs consist of two components–price and rehab costs. For rehab costs, you’re determining an estimate of putting the property in rent-ready condition, either by estimating costs from your own experience (that’s what we do) or by obtaining pricing materials and obtaining labor bids (that’s when we find out how wrong we were).

You may have a set minimum price for a property (oftentimes the case with HUD properties, estate sales, or bank-owned properties) and calculate the capitalization rate to determine how the property compares to other opportunities. Alternatively, you might use a capitalization rate, at least to some degree, to determine how much you’re willing to pay. That is, you may determine that you are able to buy comparable investments with an 8% cap rate, so you calculate the maximum price that you’re willing to offer as

Applied to TWA, with some fudging

For purposes of illustration, I ran the numbers on the TWA properties for a 12-month period–about mid-2006 to mid-2007. Using our prior naming conventions, here’s how it shakes out:

Beyond the cap rates suggesting that The Ranch is the best of the three properties, we might determine from these calculations that future investments should be in the range (or higher) than our existing properties since we know that these rates are achievable.

However, a couple of important notes here. First, we are using actual NOI for the 12-month period except that I have applied a 5% vacancy factor. Our vacancy rate on the three properties was zero for this period, but a reasonable vacancy allowance is important for purposes of projections. While any assumption, consistently applied, wouldn’t change how cap rates compare, using the same vacancy rate for different types of properties (again, multi-family versus single-family for example) probably diminishes the accuracy of the comparisons.

Second (and this is some of the fudging part), I’ve used historical data for one year for purposes of illustration. Why this particular 12-months? Actually, the reasoning is pretty simple. We finished the rehab for The Problem Child near the beginning of that 12-month period, and I wanted to work in three example calculations. (The Loft is conspicuously absent because we’ve owned it for less than a year). However, by picking a sort-of random 12-month period, I only captured actual costs, like maintenance and repairs, for that period. For example, I noticed for that period that maintenance and repair costs were extremely low, which in part suggests the higher cap rate. A longer period would be more reflective of true maintenance and repair costs, which is what you’re going to try to capture in your projections for purposes of evaluating potential investments.

Conclusion–Good Investments or Bad Investments?

I would suggest we don’t have enough information from capitalization rates to determine whether a property, in the abstract, is a good investment or bad investment. Rather, capitalization rates are probably better at determining, between properties, which is gooder. Well, you know what I mean.

In some upcoming articles, we’ll be looking at some measurements of returns that start to address the good investment/bad investment question. In the meantime, feel free to leave a comment on criteria that you use to evaluate real estate investments.

Recently, I wrote an article about our experience in buying our first four properties. In the next couple of articles, Rob and I will be writing about three methods of comparing potential real estate investments and applying them to the TwoWiseAcres empire, such as it is. In this first article, I’ll be tackling Gross Rent Multiplier (when the mood strikes, I’ll be short-handing it as “GRM”).

But First, A Word about the North

While preparing this article, I ran across this interesting article at Quest for Four Pillars talking about GRM and Capitalization Rates for a couple of properties in Toronto. Besides being a good post on these measures in the real estate investing arena, it reminded me that TWA has the occasional reader in exotic places, such as Canada or even Silicon Valley, as well as the U.S. Considering that, I thought I would start with a few preliminary notes that we hope will assist our readers. First, whenever discussing percentages, we will be using the U.S. standard for determining percentages (i.e. 1/100 = 1%). I don’t know the Canadian equivalent, but I’m pretty sure you’d need a different calculator. Second, any reference to dollars will be in U.S. dollars. Again, I’ll have to plead ignorance as to the Canadian measurement of currency (Rob thought doubloons, but I’m fairly sure that’s Spanish) or its current relative worth. Third, and perhaps most important, if you are a U.S. resident considering real estate investments in Canada, or vice versa, be forewarned. Any resulting cashflow is unlikely to work in your home country’s soda machines.

Use Gross Rent Multiplier, But Rely on it Little

In the search for real estate investments, this is the easiest way to get a quick reference point to assess the income potential for a property. GRM is calculated simply by dividing the purchase price by expected rents. For example, assume you’re looking at a property with a price of $100,000 and estimated annual rents of $10,000. GRM is $100,000 ÷ $10,000 = 10. Because we want to pay the lowest price possible for the highest rents, a lower GRM represents a better potential investment. Conversely, GRM might be used as a method to determine how much you’re willing to pay for a potential investment. For example, if you’ve determined that you can purchase comparable real estate investments with a GRM of 10, you may determine that the most you’re willing to pay for a property is 10 times annual rents and determine an offer accordingly.

So, let’s take a look at the TWA properties in all their GRM glory. Since I elected to give the properties nicknames, rather than the typical “property no. 1, property no. 2, etc.,” in my first post about the houses, I’ll stick with the names.

And (drumroll please) the Loft wins! Or does it? GRM considers only the price of a property and not necessarily the costs to put the property in rent-ready condition. It also fails to take into account differences in operating expenses, such as maintenance, vacancy rates, and property taxes, which may substantially change the returns from one property to another. Consequently, reliance of GRM as a sole measure of value is incomplete at best. However, GRM can allow you to quickly rule out properties that are priced too high and identify those worth exploring further.

We’ll be returning to alternative measures that will provide further information in evaluating potential real estate investments.

In the meantime, with respect to Four Pillars, here are other important Canadians (although I don’t know who the guy is on the right):

In our first installment of buying HUD homes series, we listed some common myths about buying a HUD home. In this second installment, we’ll walk through the basics of the HUD website and an overview of the information available online for HUD homes.

A little background, Most of it accurate

HUD is the Department of Housing and Urban Development (They were originally known as “DHUD” but they all got together and thought “HUD” sounded a lot cooler). It administers the FHA mortgage loan insurance program. As part of that function, it buys properties from private banks after foreclosure for the FHA insured amount of the mortgage loan. HUD homes consist of 1 to 4 unit residential properties.

After HUD takes ownership of a foreclosed home, it offers the home for re-sale. Private management companies, under contract with HUD, manage the sales of HUD homes, including listing the properties with a real estate broker, conducting inspections, and providing a website portal for listing and selling the properties. Because different management companies are awarded contracts to manage different regions (such as one or more states), the information available through listing websites, the bidding process, and even pricing of the homes differ to some degree between companies and therefore from region to region.

Navigating the HUD Site

We’ll start with the HUD Homes main page. This page (shown below) has links to all fifty states, the District of Columbia, and U.S. Territories (just in case you’re looking at property in the Virgin Islands):

To reach the HUD Home listings in Virginia, click the link provided: http://www.tenmanagement.com/listings/state.do?code=VA. Although the layouts of the external listing sites differ, the sites provide generally the same information and search functions. The Virginia website provides three different search categories: Public, Hurricane Evacuees and Dollar Homes (no, unfortunately you can’t buy them for a dollar). Here is what the page looks like:

For our purposes, we are interested in the Public category. As you can see, properties can be searched by various criteria, such as location, price range, or properties with price reductions, or you can choose to list all available HUD Homes in Virginia if you prefer. Clicking on the price reduced properties link produces a list of price reduced homes that can be sorted by HUD case number, city, list price, list date, or bid open date. Click here to see what the list looks like.

Information on Specific HUD Homes

Clicking on an image of the home will cause a detail screen for that property to display, which includes a map, the number of bathrooms and bedrooms, the list price and date, a picture of the home, the square footage, year built, and notes concerning the condition of the property. Here is one listing taken from the Virginia website: (clicking on the image will enlarge it–or register you for various magazine subscriptions. We can’t remember how we set this one up.)

As you can see, this particular property is a peach. Apart from the picture, take a look at the notes section. Fun issues like the presence of “deteriorated lead based paint” and “cracks in the foundation”, among others, await you for this potential purchase. Also note the Property Condition Report link under the “Related Documents” section. The Property Condition Report contains further details about the property from the HUD inspection, including a list of deficiencies with HVAC, plumbing and electrical systems.The property-specific information available through the HUD website can really save some time in narrowing the list of potential real estate investments. However, it’s best used as a screening tool. In our experience, the Property Condition Report often contains some inaccuracies, and the thoroughness of the inspection seems to vary from region to region. It should never replace your in-person inspection of the property nor be relied upon as substitute for a professional home inspector.

In the next installment on our series on buying a HUD home, we’ll be looking at the bidding process and some tips on determining a bid that’s likely to be accepted. In the meantime, feel free to add the above property to your portfolio. Here’s one of the inside pictures from the Property Condition Report: (clicking on the image is likely to avoid buyer’s remorse).

We’ll be taking a pass on this one.

You can buy a HUD Home and pay the costs of repairs and improvements for 80% or less of its fair market value. We’ve done it. We bought our last home for $112,500 and spent $12,000 to rehab the property for a total cost of $127,000. The home has an appraised value, after improvements, of $158,000. So, we were able to buy the home and put it in rent-ready condition for 21% less than its fair market value.

In this series of articles, we are going to walk step-by-step through the process of buying a HUD Home. Along the way, we will address some common misconceptions about HUD foreclosures and reveal how we determine HUD’s minimum acceptable bid for a property, a critical step to buying a HUD Home at a great price. Over the next few days, this series will cover the following topics:

* What is a HUD Home and how do you find them
* How to bid on a HUD Home
* Unlocking HUD’s Secret Minimum Acceptable Bid
* How to Use HUD’s Bidding System to Find Great Deals

This Ultimate Guide to Buying a HUD Foreclosure Home is an ongoing project. As we publish additional articles, we will add links to this page so you can easily navigate to the information you need. These first few articles will get you started in the right direction if you’re looking to buy a HUD foreclosure home at a good price. First, let’s address some common myths and misunderstandings about HUD Homes.

Myth #1: HUD Homes are only available to homeowners

HUD Homes can be purchased by investors and homeowners alike. However, HUD’s bidding system provides a preference to those who plan to live in the home by first opening only to owner-occupants. But if no homeowners submit an acceptable bid during this initial period, HUD opens the bidding to all buyers, including investors.

Myth #2: HUD Homes are only found in bad neighborhoods

Each of the HUD Homes Mike and I have bought have been in safe, family-oriented neighborhoods. In fact, most of the homes are just minutes from my childhood home. To be sure, some HUD Homes are in some rough areas, but many homes are in middle and upper-middle class neighborhoods.

Myth #3: HUD Homes are in terrible condition

The condition of HUD Homes varies drastically. Our first HUD Home was in great shape, requiring mainly cosmetic improvements such as new carpet and paint. There are HUD Homes, however, that do require substantial renovation such as new kitchens and roofs. As an investor, the best deals are often those that require the most work. We have found that to be true, but if you’re looking for a home that requires less upfront work, they can be found through HUD.

Myth #4: HUD Homes can be purchased for a $1

If only it were that easy! Investors and homeowners cannot buy a HUD Home for $1. So how did this rumor get started? HUD does offer single family homes for $1 to local governments who, often in partnership with non-profit organizations, improve the home and offer it as low-income housing. These HUD Dollar Homes must have been listed by HUD for six months before entering this program. You can read more about the HUD Dollar Homes here.