Transcript Income Property Survival Guide

Income Property Survival
Guide
Joe Lumbley, President
JP Lumbley & Associates, LLC
www.dallasincomeproperties.com
Get Rich Quick (GRQ)
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Main purpose is to sell seminars and books
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How else can they afford 30 minute infomercials?
Sell the dream, not the reality
So, why not sell the truth?
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Can’t give the truth away in most cases, much less
sell it
It’s not what people want to hear. It’s not the easy
way.
The Rare GRQ Deal: Make
Haste Slowly
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Sometimes lightning strikes.
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But only those who’ve managed to place a
lightning-catcher in just the right place will benefit
How to catch lightning
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Think ultra long-term. Befriend lots of property
owners. Treat them right. Stay in touch. Be very
low-key. Don’t try to convince or to sell. Learn
from these owners. Let them know you appreciate
it. Ask their advice on other deals.
Let them know that you’d like to become an owner
yourself someday.
Wait for them to decide to sell and make them an
offer then.
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Happens most often with property managers, relatives
Get Rich Quick: Fallacies
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Most sellers are intelligent people. Many are
also active buyers themselves, and they’ve
seen it all.
 GRQ (get rich quick) deals, if they’re even for
real, are the extraordinary deals. You cannot
base a long-term business plan on just
finding extraordinary deals. Remember the
bell curve
The Bell Curve
What they didn’t cover in the
get-rich-quick books
 Classic
pyramid. Only those at the top
make any real money.
 Professionals will just flat-out ignore
you.
 Sellers are seldom desperate enough to
accept such flaky deals.
Advantages of Real Estate
Investing
Everybody’s got to live somewhere
 Not making any more of it—finite supply
 History of year-to-year appreciation
 Tax benefits
 You control it more than stocks & bonds
 You already understand most of the
mechanics of the process
 Ability to negotiate price & terms
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Disadvantages of Real Estate
Investing
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Time-consuming. Plumbing calls in the
middle of the night
 24 x 7 job
 Stressful. Lots of money involved
 Antagonistic. Much of real estate is a zero
sum game.
 Not liquid
 Lots of commissions & fees
 No guarantees. No FDIC/FSLIC. No safety
net.
Leverage
What is leverage?
What can you leverage?
 Money—OPM, Other Peoples Money
 Rents
 Net Worth
 Reputation
 Time
 Your network
 Information
Rent Leverage
 Income
property is valued based on
revenue, not just real estate
 Typical apartment deal valued at 6X
gross rents
 20
units at $416/month ~ $100,000
revenue. Value is $600,000.
 10% rent raise to $458/mo. ~ $110,000
 New value is $660,000.
Net Worth Leverage
 Higher
net worth = more business
respect, better business terms, more
opportunities
 Net worth for most part is STATED.
Very seldom do you need to get
appraisals to back it up.
Reputation Leverage
 Do
more deals = become more of a
known factor.
 See Net Worth Leverage. Same
concepts.
 Works both ways. Negative reputation
can kill you. It’s still a small community.
Time Leverage
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What is the only thing that is 100% finite and
always in limited supply? Time.
 Get other people working for you. Referrals,
leads, employees, tenants, brokers, loan
brokers, lenders.
 Develop systems to do deals efficiently and
quickly
 Don’t waste your own time
 Don’t let others waste your time for you
 Deal with professionals. Don’t try to do
everything.
Seller-Centric Buying
 Deal
doesn’t come down without both a
Buyer AND a Seller.
 Both
parties have to be satisfied
 Seller has inertia on his side
 Find
out what the Seller wants
 Give him the minimum you can to make
him happy.
Typical, real world deals
 Leverage
 20%
down at local banks, good local credit,
local history
 25% down at more conservative lenders or
on more borderline deals
 30% down at some lenders, who may allow
a seller-financed second lien.
Seller Financing
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Sellers almost always want the cash. Cash
talks. Sellers listen.
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Most of the time, sellers know the real values of their
buildings. They’ll be real happy to show you how the
rents will increase 50% but they’re not stupid enough to
base the values of their second-lien note on those
projections.
When money’s easy, seller financing is very
hard.
 When money’s tight, seller financing is more
likely
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If I can’t start with zero cash,
how do I start?
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If you don’t have good credit or you don’t
have money or assets for a down payment,
you need to work on those problems first.
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Build up your credit rating
Save up a war chest
Own your own home first
Start making contacts
Keep watching for the rare but sometimes
attainable zero/low down deal but don’t build your
future plans on being able to find it.
Other Peoples Money--OPM
 Purchase
money
 Improvement money
 Grants
 Hard money
 Tax incentives
 Credit cards
 Construction money
Money Sources
Whose money?
 Lenders
 Sellers
 Partners
 Government
 Tenants
 Buyers
 Family & Friends
 Retirement money
 Credit Cards
 Home equity
Taxation
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Understanding real estate taxation is key to
the entire process
 Ad Valorem taxes are property taxes. They’re
NEGOTIABLE. Don’t take tax increases lying
down
 Income taxes are partially sheltered by
interest and depreciation deductions
 Capital gains taxes are due on sales profits
 Recapture taxes are due in year of sale and
are high at 25%
 Understand 1031 exchanges
Locating Income Property
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Do your homework
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Pre-qualify with lenders
Have your down payment lined up
Quantify what an acceptable deal looks like.
Build your network
 Identify and concentrate on your market
 Use brokers
 Watch the ads and the online listing services
 Walk the area. Find properties you like. Talk
to the owners.
 Track financial news and trends
Purchasing Income Property
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Be ready to move quickly
 Understand the seller’s
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Motivation
Cash needs
Timeframe
Special needs
Offer with a respectable earnest money
deposit. Offer reasonable option fees.
 Don’t waste your time or the seller’s.
 Give yourself a short-term inspection clause
that allows you full access to property and
records
The Purchase Process
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Make an offer
 Negotiate price and terms of an offer
contingent upon financing and inspections
 Inspect the property and books
 Re-negotiate price and terms to release the
inspection contingency
 Negotiate and obtain any loans or financing
 Close the deal
Important Terms
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Net Operating Income = NOI = Scheduled
revenue – vacancy – expenses
 Capitalization Rate = CAP Rate
 GRM = Gross Rent Multiple
 Cash Flow = NOI minus debt service
 After-tax Cash Flow = Cash Flow – income
taxes on the revenue
 Cash-on-cash return = cash flow / cash
investment.
 Internal Rate of Return = IRR = current value
of the entire stream of income. Includes final
sale of property so includes appreciation
Evaluating the Income Stream
 You’re
not just buying real estate.
You’re buying a stream of income to be
received in the future.
 Actual rents or street rents?
 Street
rents through rent surveys in the
area.
 Actual rents (collected rents) are AFTER
vacancy, so don’t try to apply a vacancy
rate if you’re looking at actual receipts.
Vacancies
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Apply a vacancy rate to street rents or proforma rents
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View over a year’s time
Your mileage may vary. Management can play a part
here
Vacancies also affect other income, such as
laundry and vending income
 Vacancies also affect expenses such as
utilities and unit cleaning and make-ready
 Also include collection losses due to
nonpayment of rent
Quality of the Income Stream
Is it real? It’s very simple to fake up rent rolls.
 Is it steady or seasonal?
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How long have the tenants been there?
What’s the turnover?
Are the tenants all related or all working for the same
employer?
How many tenants are behind on their rent right now?
How many evictions have they had in the last year?
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Affects legal costs and fees
May indicate poor tenant screening
How many units are non-revenue?
How much is it worth?
Multiple ways of approaching value. All
contribute to overall pricing
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View it like a bond
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View it like a stock
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GRM = Gross Rent Multiple = Price/Annual Income
Lower is better
GRM ~ earnings multiple
View it like a house
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CAP rate = NOI/price. Lower CAP=Higher Price. CAP
rate ~ interest or yield on a bond
Price per unit
Price per square foot
View it like a business
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Cash-on-cash return
After-tax cash-on-cash return
View it like a bond
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This is an “intrinsic” method of valuation
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Does not consider financing. Looks at value as
though there were no financing at all on the
property.
Not affected by leverage
Doesn’t consider taxation
Doesn’t consider appreciation in value
Adaptable to any type of income property
Conservative approach. Bankers use it, as
do big all-cash buyers like pension funds
View it like a Stock
 Stock
is really a pretty weak analogy,
but bear with us
 GRM is like an earnings multiple based
on gross earnings
 Doesn’t
consider financing or leverage or
taxes
 Considers appreciation to a small degree.
As gross rents go up, value goes up.
View it like a House
 Comparable
sales
Limited MLS information available
 Some specialized registries like Roddy Report
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 Price
per unit
 Price per square foot
 Comparable GRMs
 Comparable CAP rates
 Comparable cash-on-cash
View it like a Business
 Before-
and After-Tax Cash flows
 Considers
financing
 Affected by leverage. More leverage =
more money financed = more debt service
= less cash flow
 After-tax cash flows take into account
income taxes
View it as Income Property
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Melding of all the methods above
 Internal rate of return (IRR) considers
everything
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Cash flow
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Appreciation
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Allows you to assume net cash in a sale down the road
Taxes
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Allows you to assume % increases in revenues and
expenses
Income tax
Capital Gains
Recapture
Alternative investments. IRR allows you to
assume a reinvestment rate of return on cash
flows
The Process of Valuation
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Use house-like valuation to eliminate obvious
clunkers
 Evaluate the income stream
 Use GRM and CAP rates to further refine
whether you even want to spend more time
on the deal and to get closer on price
 Use business-like methods to refine further
and to decide whether the investment meets
your criteria.
 Use IRR to determine property’s value to you
and to prepare presentation materials for your
lenders.
What next? Expanding your
holdings.
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Can use IRR methods to calculate your
current IRR on existing investments
 Look at the rate of return curve
 Sell, trade, or refinance when the IRR drops
below what you can get on new deals
 This method can work to help convince
sellers that it’s OK to sell.
 Refinance and pull cash out of the deals—
this is the only place where GRQ concepts
really apply.
 Consider 1031 exchanges rather than sales
Summary
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Do it NOW. How long do you plan to live?
 Forget everything you learned in television
seminars
 Develop a method that works for you and
then stick with it. This is business, not
emotion.
 You’re not looking to LIVE here. You’re
looking to cash the checks from others who
live here.
 Remember, not every at-bat is a home run. If
you only swing at home run balls, you’ll miss
a lot of singles, doubles, and triples.
For more information
 Joe
Lumbley 214-941-3417
[email protected]
 Monte
Self
[email protected]
 www.dallasincomeproperties.com
Thanks for your time. Hope you gained
something from this presentation!