Ken McElroy
Many people do not get into real estate investing—even though in my opinion it is the best investment class in the world—because they do not want to fix toilets or deal with tenants. (Location 71)
Property management is where most of the profits are made or lost. Many people lose money in real estate simply because they fail to manage their properties properly. If they cannot control the occupants, income, and expenses, the property soon goes downhill. (Location 76)
All you need is a good real estate deal that makes sense—one that has profit potential and is based on solid financials. (Location 117)
A cool $116,000 was what I paid and I put down $20,000 out of my own pocket. You’re probably thinking, “See, I knew you had to have some cash to get started in this business.” (Location 120)
Well, I did that deal before I knew better. (Location 122)
Once you have located a real estate opportunity, the task is finding investors who are looking to earn a good return on their money. The first deal you do, granted, is the most difficult, because you are an unproven entity. But trust me: It gets easier and easier with every successful deal you put together. (Location 131)
But why rule out a $2 million, fifty-unit building? Believe it or not, any of these properties are within your reach. Of course right now you’re thinking, “No way! I can’t afford a $2 million mortgage!” And to that I say, you may be right, but you don’t have to be able to afford it. Here’s why. Mortgages on smaller properties like single-family homes are almost always guaranteed through the buyer’s own personal earning potential and wealth. You may be surprised to learn that larger investment property loans are secured by the asset itself. In other words, instead of the $2 million building riding on your own wealth, it is riding on its own valuation. This already is less risk to you. (Location 142)
Five years later, I sold the condo for $121,000, a gain of $5,000. Recently we refinanced the 182-unit building, which we had owned less than a year. Its newly appraised value was $11.3 million, more than $2 million above what we paid for it. And since I own 10 percent of the project, I made over $200,000 in less than a year. A testament to the power of buying and managing right and managing well. (Location 151)
This example also demonstrates risk related to valuation. When you buy a house or condo and rent it out, appreciation of the property rests solely on the appreciation of the surrounding neighborhood. You better have bought in the right neighborhood, because there is little you can do to increase the value of your property. By contrast, appreciation in commercial property, like apartment buildings, is based on the cash flow of the property itself. The more money it makes, the more money it is worth. (Location 154)
No money down is another way of saying that the property is 100 percent financed. That means a much larger part, if not all, of your cash flow is going toward the monthly payment. In no-money-down deals, you’ll be paying higher interest rates because there is greater risk to the lender, have higher loan costs, and have virtually no money to improve the property or even repair it should something break. With this model, you are banking on the property appreciating to make money rather than improving the operations of the property and making money through cash flow. (Location 166)
I believe that buying and holding income-generating assets like rental properties is how you build wealth. You may say, “But I need the capital gain—the additional equity I’ve made on this property—to buy a second bigger rental property with more units. That means I have to sell the first one.” In my experience this just isn’t true. What you need is a second investment deal that makes sense that you can bring to investors. (Location 174)
If you want (Location 184)
the money out, you don’t need to sell. You refinance the property and pull out what equity you can. (Location 184)
In the case of the 208-unit property, we will refinance and we will use the equity that we pulled out of the property to pay back our investors with interest. It’s a great system and best of all you still own the property, you continue to receive cash flow from the building in the form of rent, and as the building appreciates, you can refinance and take the gain—tax-free—again. That’s the money that you can use for other deals and it’s what I do every day. (Location 185)
I believe there are two voices: the voice of reason, and the voice of self-doubt. The voice of reason is common sense; the voice of self-doubt is your past leading your future. (Location 215)
The investment real estate business is something you should want to do and may even need to do. It’s work. To be truly successful, especially in the beginning, you will be involved in the day-to-day (Location 237)
activities of finding and evaluating property, negotiating deals, overseeing contract repair work, possibly even managing the property once it’s yours. I can honestly say, I find the business rewarding, fun, and because of that, it is profitable. (Location 238)
After all, if you work during the week at another job, you will have to search for and evaluate property on the weekends. You’ll need to make phone calls when you can during the week or in the evenings. There’s always a way to make your dreams come true…as long as they are truly your dreams. (Location 245)
We’re doing a deal in Portland, Oregon. I live and work in Arizona. I hadn’t been to Portland in over ten years. Anyone I had once known there was long since gone. Neither I nor anyone else in my company knew a soul in Portland. What we did know was that the city was situated on two rivers and that unemployment was high. The latter meant that the people who owned (Location 254)
property were probably not doing so well. And to me that spelled buying opportunity. We had one big problem: We knew about the city, but we didn’t know a single person in the city. We figured the market conditions were at least worth a plane trip and a few days in Portland. Before our trip, we made our minds up to find our team, at least the start of it. So we went on the Internet and looked up property managers, city officials, brokers, and so on in preparation for our trip. We were not about to travel that far and not meet with anyone who could educate us about the market. As a result, we had ten or twelve meetings over a period of two days. It cost us a few lunches and dinners, but we had the beginnings of our team. (Location 256)
With the method in this book, you’ll find out that the listing price is (Location 274)
meaningless. There is no point negotiating based on this number, and actually doing so is a recipe for disaster. That’s because in most cases, the listing price is the seller’s opinion of what the property is worth. It is not founded on the actual operations of the property. (Location 274)
The only way you’ll know a lot about real estate is to begin in real estate. Once you do that, you’ll meet people, learn your market, see the patterns, and understand the trends. (Location 291)
First, you have to set goals. Goals will be the foundation of the roadmap for your success. They will also tell you when you have arrived, so you can pat yourself on the back. (Location 313)
Second, you have to persevere. Quitting when things get tough doesn’t produce winners. In fifteen years, I could have quit a hundred times. I’ve (Location 315)
Having a goal is not optional. Goal setting is step number one in the process. In this chapter, you’ll learn how to set your goal, what a realistic goal should look like, and set milestones to achieve it. (Location 330)
It wasn’t until years later that I really understood goal power, the power you feel when you’ve set a target and you concentrate all your efforts on hitting it. It makes you focused. It makes you decisive. And ultimately it makes you successful. (Location 335)
Maybe your goal is to buy one investment property in a twelve-month period. Or maybe you want to earn $5,000 per month in income within two years. (Location 344)
Goals that are vague are hard to attain and are even harder to stick to. If there is no time limit, dollar amount, or rank comparison, for example, how will you know you (Location 352)
have “arrived”? It’s virtually impossible. (Location 353)
Goal setting requires you to be honest with yourself and reflect on what you really want in life. That means taking the time to think about what you want for yourself and your family right now, in the years ahead, and long into the future. (Location 362)
The Strategic Coach Seven Laws of Lifetime Growth: 1. Always make your future better than your past. 2. Always make your contribution (Location 370)
bigger than your reward. 3. Always make your learning greater than your experience. 4. Always make your performance greater than your applause. 5. Always make your gratitude greater than your success. 6. Always make your enjoyment greater than your effort. 7. Always make your confidence greater than your comfort. (Location 372)
There’s another terrific program called Setting Family Goals by Charlie and Barbara Dunlap. This program focuses on balancing your marriage, family, and business. (Location 378)
marriage? If you were like me, planning work was at the top of the list and I spent very little time planning my family goals. (Location 380)
goals should be general, but it is the specific to do’s and the objectives that need to pass the SMART test. “S” specific “M” measurable “A” agreed upon in writing “R” realistic “T” time activated (Location 384)
It’s been said “a goal not written down is a wish.” I’ve also heard “a goal is nothing more than a dream without a time limit. (Location 392)
You can reach Charlie Dunlap at Chdunlap3@aol.com for further information. (Location 394)
Achieving my goals meant I had to do four things really well: Communicate, plan, persevere, and stay focused. (Location 419)
Here’s an example of a hypothetical goal: We will acquire one eight-unit property in your metro area within the next twelve months that will generate at least $4,000 of average annual income over the next five years. (Location 425)
Contrast that goal with this uninspired and non-motivating goal statement: I want to invest in some real estate and am looking for a good rental property deal that will supplement my income. (Location 428)
If you share a goal as written in the first example with a few real estate agents, a few mortgage brokers, and some property managers, I know you will get calls. (Location 432)
They will bring you opportunities because they can tell you are serious, that you know what you want, and that you have a set time limit. (Location 433)
There are fundamental milestones that relate to personal behaviors and financial freedom. What behaviors should we change or eliminate? Behavioral Change To-Do List Taking the same route to work every day. Hour-long lunches. Watching TV every night. By changing these three simple behaviors you are setting milestones that help you achieve your goal. Taking a different route to work gives you new scenery and helps you (Location 446)
learn about the market and the properties within it. (Location 449)
Finally, eliminating TV, or at least reducing your viewing time, frees up countless hours in the evenings to work on your business. Look at your own behaviors and modify them to achieve your goals. (Location 452)
Financial Freedom To-Do List (Location 455)
Add up your personal expenses. Determine what you can reduce, eliminate, or do without. Figure out how many properties you need to buy to cover the total. (Location 455)
Business To-Do List Find your team. Evaluate the market. Find a great property. Assign a valuation to the property. (Location 460)
Establish a property plan. Develop a budget. Manage the property. (Location 461)
If you’ve ever been part of anything entrepreneurial or even if you ever built something from scratch, then you know endeavors such as these take twice as long as you think, require twice as much work, and cost a lot more than you expected. Those are facts of life, so I am never surprised when they prove to be true. (Location 464)
There’s a funny thing about goals and success. The closer you get to achieving your goal and the more successful you become, the more opportunities will come your way. You’ll be tempted on almost a weekly basis with new properties and other business opportunities that promise to increase your revenue. (Location 477)
After we had built our property management business to a significant size and had begun looking for ways to increase revenue, I decided to start a carpet cleaning company. It made sense at the time; after all, we had thousands of apartment units with carpets to clean, why should that business go to some other company? That single lesson cost me a quarter of a million dollars. But even more than the money, it took my eye off my goal for at least a year or two. It slowed the pace of our growth. Our company would have achieved its goal a lot quicker if it hadn’t been for this diversion. (Location 481)
As opportunities present themselves, ask yourself, “How many balls do I want to juggle? If I take on this project can I manage ten more balls in the air? And more importantly, will taking on this project get me closer to achieving my goal?” If your goal is to buy an eight-unit property and earn an average of $4,000 per year in the next five years, will a hot deal on a single-family home get you closer to achieving that? No it won’t, and in fact, it will divert your attention from the original goal and certainly not net you $4,000 per year in income over the next five years. (Location 485)
CHAPTER TWO ACTION STEPS • Understand and believe in goal power as a means to accomplish your dreams. • Search within yourself and set a goal for your real estate investment business. • Overcome goal fear, which is the fear of telling others your goal in case you fail. • Find someone to whom you can be accountable. • Tell everyone you see about your goal. • Set milestones, the baby steps, for achieving your goal. • Tell everyone about your milestones. (Location 493)
Well, in the business of investment real estate, you can’t afford to be a lone ranger. In fact, it’s (Location 505)
impossible to accomplish your goal on your own no matter what your goal is. (Location 506)
Having a team of experts on call is not free and it is not cheap. Those are the two biggest reasons why many inexperienced investors make a rookie mistake: They try to do almost everything themselves. Sure, they may save a few dollars in the short run, but they usually lose in the long run. (Location 508)
One investor who decided to go it alone is a man from Seattle who called us right after he purchased a 100-unit property and asked us to help him manage it. The key word here is “after.” (Location 516)
This man’s laziness on the front end cost him tons of money. I wonder why now, but we did take on the management contract for this property and the price tag was pretty steep to get this place back in shape. (Location 522)
This is just one example. There are thousands of others. The point here is simply that the wise investor pays on the front end and reaps the rewards on the back end. The fees it would have cost the property owner from Seattle to have his Phoenix team visit the property and file a report or two were a pittance when (Location 528)
compared with what it cost him out of his own pocket to get his investment in shape. (Location 530)
And here’s one more bonus. Often it is the team you establish that becomes the foundation for your entire network. Think of your network as your lifeline. Not only will they help you with the deals you’re working on now, they are usually the ones who will bring you your second, third, and fourth property opportunities—particularly if you have voiced your goal to them clearly, as discussed in the previous chapter. (Location 532)
I believe that having family members on your team, or even partnering with them, is a good idea as long as you make an informed decision and know what you are getting into. (Location 539)
Your All-Important Team The following lists include all the people and professionals you will eventually have on your team and how to evaluate and select them. (Location 570)
an attorney, an accountant, a real estate broker, and a property manager. (Location 574)
Before you do anything, even print your business cards and letterhead, get your business set up correctly. To do that you’ll need to talk with an attorney who will advise you about setting up your company. Should you set up a corporation, a limited liability company, or some other business entity? You’ll need to know the pros and cons of each to make that decision. Regardless of which you choose, having a formal company established will protect your personal assets and provide tax advantages to you. (Location 576)
The property search team includes people you will most likely have to find on your own. I recommend interviewing several professionals in each field until you find people you like, who know the market, have your same level of integrity, and who understand they are there to help you achieve your goal. (Location 584)
Real estate broker. The real estate broker will help you understand your market and help you find properties. • Property manager. This person will help you assess the properties you are considering from an operational perspective. They will give you a solid idea of what you are getting into. (Location 588)
Your property search team will most likely refer some or all of these professionals to you as you need them. That’s another reason why who you choose as your real estate broker and your property management contacts are so critical. (Location 591)
Attorney. Your attorney will certainly help you set up your business, but he or she will also help you wade through letters of intent and purchase and sale agreements. • Lender or mortgage broker. Find a lender or broker who understands the business of property investing. Not only will they lend you money, but they will also provide you with leads on other properties that are ripe for sale. • Investors. By communicating your goals and doing the work of building your team, you should find several sources of equity who will entertain investing in rental property. • Contractor/Rehab specialist. Contractors see things you and I don’t when it comes to walking a property. Before I sign any deal, I (Location 594)
CHAPTER THREE ACTION STEPS • Understand it takes a team to be successful in this business. • Determine whether you want a partner. • Evaluate partner candidates based on the qualities of a good partnership. • Establish your business team (Location 623)
first—an attorney and an accountant. • Begin networking to find other team members for your property search team, your offer team, and other team members you’ll need from time to time. (Location 626)
“How do I find good investment property?” This has to be the most commonly asked question, and for good reason. There is a needle-in-a-haystack sort of quality to this whole endeavor, or at least it seems that way, particularly if you’ve never done it before. Do you look in the newspaper, grab sales sheets from real estate offices, check out the Internet, drive around? The whole thing seems so haphazard. Truth be told, there is a lot of information out there about property and a lot of ways to get that information. Maybe too many ways. (Location 631)
By walking you through my experience of buying a property in a new market I knew nothing about, you’ll see how this research method works and what you can gain from it. (Location 636)
Level One Research Level One Research is what I call the very preliminary stuff. To do it, you don’t even have to leave your house. This is research you do before you even set foot on a property, or in the case of the true story of our acquisition of the waterfront property in Portland, Oregon, before we even set foot in the town. (Location 654)
Before we settled on Portland, our goal was to do Level One Research on all the major markets in the Western United States. (Location 657)
One of the first things we did was look at all the newspapers and business journal (Location 658)
newspapers in every major Western city via the Internet. We followed the online hyperlinks to every interesting lead. For example, we’d type in a city like Denver into a search engine and up would pop a story about population growth. We’d follow it. Then as part of that story there’d be (Location 659)
a link about school funding. We’d follow it. What we found was very interesting, particularly in Portland. First we discovered that the city has an urban growth boundary that we felt would limit the supply of rental property in the future. That’s a good thing! Next we found that the city of Portland was progressive in their downtown planning and progressive in terms of transportation with their light rail, bus system, taxi system, streetcar system, and even plans for a future water taxi on the Willamette River. We also found that living and working downtown was in high demand and that the downtown employment picture was favorable. (Location 661)
Then we started to uncover some of the city’s limitations. On the downside we found statewide unemployment was leading the country with a whopping 8.1 percent. This was an important finding because when we saw that statewide number compared to unemployment in downtown Portland, we knew for us the only opportunity was downtown or possibly a few other suburban bright spots. (Location 666)
In most cases the opportunities to buy low are when the economy is down and the press is making a living by saying bad things about you. That was Portland. (Location 678)
Portland was a market with good employment, that it was progressive and forward-thinking, that it had a very high cost of home ownership, and that it was in high demand. (Location 681)
We were prepared, however, to conduct Level Two Research once we got there to develop a team that would help us understand the market and maybe even lead us to property. (Location 686)
Level Two Research is about meeting face-to-face and we didn’t waste time. Even before we arrived we had made phone calls to set up meetings with property managers, commercial brokers, commercial lenders, city officials, and businesspeople like the publisher of the local apartment guide. (Location 689)
It was during this time that we really started narrowing in on our submarket. In any economic downturn, it’s always smart to be in the market that will turn positive first. That’s true of anything in business whether it’s the stock market, a business sector, or real estate. So we looked at several submarkets and determined that downtown Portland was strongest at this point and would be the first to rebound based on the simple economics of supply and demand, its diversified employment base, and lack of affordable housing. We learned that as the economy rebounded, the downtown market would be the area that rebounded first. While we were meeting with all our contacts, we clearly communicated our goal—to buy a 200-plus-unit apartment community—and asked them a variety of questions like: who their favorite property management (Location 699)
people were, what lawyer they recommended for legal work, if they knew any good accountants. (Location 706)
We first called every team referral and asked them all the same questions we asked of our initial contacts in Portland. Not only did they give us their opinion and insights, they pointed us in the direction of numerous Web sites, analyst newsletters, economic development offices, city government contacts, and other Portland businesspeople who could add the finishing touches to our picture of Portland and could keep us on top of happenings in the area for as long as necessary. (Location 712)
I don’t buy anything without researching the market first. Even in Phoenix, which is a market I know extremely well, I do research before I buy anything. Things change, markets and submarkets go in and out of favor, big projects like highways change the patterns and flow of a city. There is always something. (Location 725)
CHAPTER FOUR ACTION STEPS • Become familiar with the resources available online like: newspapers business trade publications government Web sites trade organizations • Realize that government officials and staff people work for you and that meeting with you is part of their job. • Test your research abilities—see how much information you can find out about your hometown: online through face-to-face meetings through in-depth follow-up phone calls. (Location 730)
First impressions and outward (Location 745)
appearances of cities or towns and the neighborhoods within them—also called markets and submarkets—can be deceiving. (Location 745)
So can buying anything in a market that you know nothing about. You’ve heard the saying, and it’s true, a lot of swampland gets sold to unsuspecting buyers not just in Florida but in every city and town across America. (Location 746)
If we learn anything from all those poor people who have purchased swampland with the hopes of striking it rich, we should take away one lesson: (Location 750)
The market is more important than the property. (Location 751)
The Problem with Gut Feelings Too many people purchase investment real estate on a hunch or (Location 756)
a gut feeling. And while it is important to have instincts, understand that they are the products of experience, not a right of birth. This gets back to the myths. People are not born knowing this stuff. (Location 757)
Starting off on the right foot involves doing one thing really well: evaluating your market and submarket. You must get to know your target area and become an expert in it. (Location 761)
Supply and Demand When it comes to investing in property of any kind, particularly rental property, I make sure my first objective is to get an accurate read on the supply and demand in the area. I’m not talking anything complicated, just basic economics. Supply is defined as the number of rental properties available in a market or submarket. Ideally, supply should be low and demand should be high. Demand is defined as the number of people looking to rent. Supply is easy to determine. In Portland, we asked our emerging team, specifically brokers and property managers. They had detailed data, including property names, sizes, addresses, and dates of construction. Seek out this help; why do all this work on your (Location 772)
own? Demand on the other hand is a bit trickier. I estimate demand based on occupancy rates in the area. If a submarket has high occupancy, demand is great. If occupancy is low, demand is soft. Another indicator of demand is the prevalence of move-in incentives and specials. If there are a lot of move-in specials advertised, demand is low. If rental properties are offering no incentives at all, demand is high. These are some outward signs. (Location 779)
Another factor to consider when determining supply and demand is future supply. By future supply I mean any and all new rental property that is in various stages of development, from planning to permitting to construction. Future supply is a critical indicator of how properties in the area will perform long term. If through your research you find that supply is greater than demand, you may want to stay away or at least keep looking for a better market. Your job of finding residents, generating cash flow, and increasing the profitability of the property will be more difficult. (Location 783)
true. Here rental properties, including large apartment communities, and uncountable numbers of duplexes, condos, and single-family homes seem to be everywhere. Many were purchased by hopeful investors. And now they are competing head-on for a relatively small number of renters. The reasons for this lopsided market state are no mystery. Rather they are totally explainable. (Location 790)
The Three Drivers of Supply and Demand Simply, there are three drivers of a market’s or submarket’s economics that come into play. As an investor in real estate, you’ll want to keep each of these variables in the forefront at all times. They are true indicators of supply and demand. (Location 793)
EMPLOYMENT This is the first and possibly most important indicator of demand and for good reason. If a market or submarket has lots of jobs, people will come to fill those jobs. Very basic stuff. (Location 796)
But Scottsdale wins in terms of employment and therefore in terms of demand. (Location 803)
It is a fact that population follows employment. (Location 808)
High employment can be beneficial for rental property (Location 811)
investments, but be sure to look at the whole picture. Even communities with lots of jobs can still be overbuilt, thus throwing off the delicate balance of supply and demand. (Location 811)
Employment stability is also (Location 817)
something to consider. As you evaluate your market and submarket for employment, look at how stable the employment base is. Are the companies reputable? Are their products or services in ever growing demand? Is the mix of companies diversified? (Location 817)
POPULATION In a world of choices, choose to have your first—well let’s face it, all your investment rental property where the people are! (Location 822)
That may be a bit cut-and-dried for the new investor who’s thinking about taking advantage of a “great deal” on a single-family home on the outskirts of town, off the beaten path. While it may be a wonderful property, and seem like a great deal, that’s meaningless if nobody is around to lease it. (Location 825)
In this book, you’ll find that once the market is selected, the key to success is in the property itself and valuation is a function of its operations—how well it operates now and how well it (Location 827)
will operate in the future. By operations, I mean how much income the property generates, what the expenses are, and what the overall profitability is. Operations success in this business relies on a market of renters. People certainly go where the jobs are. But they also migrate to places that have a certain persona or living experience built into the area. (Location 829)
Purchase investment property in Venice Beach and you wouldn’t have to say much more. Lots of people are drawn to this lifestyle and the persona of what living in Venice Beach means. Contrast that with the Phoenix submarket of Dobson Ranch. There are rental properties in this master planned community, but the area has no real persona that drives the multitudes to it. Sure it’s a nice place to live and a great place for families, but there is no major image that draws population. I’m sure most everyone reading this book has never even heard of it. (Location 836)
Other areas that come to mind when I think of living experience and persona are Key West, Florida, and (Location 840)
Coronado Island, California. They both are exclusive beach resort communities. Whistler, British Columbia, is another example and the name is almost synonymous with skiing and stunning alpine scenery. Gig Harbor, Washington, is a mecca for boating enthusiasts. Aspen, Colorado, is the place to ski and be seen… (Location 841)
Take some lesser known areas in Arizona: Litchfield Park, which was once known as the location of Luke Air Force Base and a lot of farms, is now readily known in the… (Location 845)
of development, a sports arena complex in neighboring Glendale, and retail everywhere you turn. Mill Avenue, a submarket of Tempe, Arizona, is well known as a youthful, happening, artistic college center. Do you understand through these examples the concept of persona and living experience? Places that have… (Location 847)
The lure of charming buildings in towns that lack employment and a solid persona have tempted even the best of us, myself included. But don’t be caught! Charming buildings in towns… (Location 851)
Unless you’re a Vegas gambler who always tries to beat the odds, stay away from markets and submarkets… (Location 853)
Now that you know some of the reasons why markets attract people, you’ll need to know how to quantify the population in your area. Here’s another time when the team comes into play. Talk to your city or town… (Location 854)
Remember, as a taxpayer, you are paying their salaries. You are their customer. Do whatever it takes to get realistic population projections, and when they rattle off blue-sky numbers ask them to elaborate on the factors they see… (Location 856)
In addition to employment and town persona as population draws, your contacts may also refer to the following: • New highways or highway extensions. These create new traffic patterns and transform areas that once seemed a long distance away, into places that suddenly seem close by. If a new highway project is slated near that single-family home off the beaten path we talked about earlier, it may not be such a bad investment opportunity after all. • Master planned communities. These large residential projects combine home and work and with them draw lots… (Location 859)
Military bases. Not all military personnel live on the base. The property around government installations is often a good investment. Just be careful of base closings, which are often in the news around government budget time. (Location 878)
Affordability. I always look at the affordability of housing in a particular market. If a single-family home is out of reach for most people, apartment living becomes a valuable option. This is the case in big cities like New York and San Francisco, which attract large populations, most of whom cannot afford homes. Look for markets where the cost of home ownership far exceeds the cost of renting. (Location 899)
LOCATION Location is the most important thing when it comes to real estate, at least that’s what everyone says. And I agree. But to me, locations have to be evaluated not based on geography alone, but based on how they measure up in relation to supply and demand. (Location 903)
Great locations have drive-by visibility. (Location 907)
Great locations are low in supply and high in demand. This is at the heart of your market evaluation. (Location 918)
The first step in buying right is knowing your market better than anyone else. (Location 919)
After reading this chapter, you should now be thinking that “your metro area” as a market is way too broad. That should be narrowed considerably. As you learn more about your own market, you will find yourself continually refining your goal and your search. (Location 925)
CHAPTER FIVE ACTION STEPS • Select one market in your state, preferably one close to home, that you may be interested in. • List every submarket or separate neighborhood. • Define and describe the employment picture of the area. (Location 931)
Define and describe the unique persona of the submarket. • Determine supply-and-demand estimates: ask your team read the visual signals • Check your findings against the information in this chapter. • Rate the submarkets based on the criteria. • Select your submarket. (Location 935)
You want to make sure you choose wisely because you will be committing time, energy, and money. You’ll be putting your heart into the effort and have big dreams of where things may lead—maybe a long-term commitment, maybe marriage. Dating just anyone, like targeting any old property, can be a huge time waster and even cost you a lot of money. I speak from experience on both counts. (Location 941)
Time and again, investors start at this stage—they work on finding a property and completely skip the preparation work. This is why the word “risk” is so often associated with real estate. Selecting the property should come only after you have assembled a team to assist you, decided upon your goal, and done the work of identifying a market or submarket. (Location 948)
By now you have found your (Location 952)
market and a submarket or sub-markets within it. The next step is finding the property that will achieve your income and profitability goals within your chosen area. (Location 952)
When you buy right you spend your days tending a garden rather than digging out rocks, Life is too short. (Location 957)
When I was just starting out in this business, I searched for property myself. Now I (Location 964)
hire someone to sift through property that is listed and not listed to find what fits my parameters. (Location 965)
For me, it helps a lot to have a precise idea of the kind of property I’m interested in. It saves a lot of time, keeps my broker and me focused, and helps make the work manageable. I am very specific about what I want to consider. For example, we’re looking in one market right now for a 150-plus-unit community in a good location with high visibility, drive-by traffic on major streets, and constructed after 1988. Even more specifically, I’m looking for owner-managed properties where the owners live out of state and have just one or two properties in the entire city. (Location 969)
Perception. Many owners wrongly believe that the investment real estate business is an investment and not a business. They think it is like a stock or a bond that they can buy and forget. In truth it is a business they need to operate. (Location 984)
You’ll want to make sure your target market isn’t too big or you will end up considering thousands of properties. (Location 990)
In San Diego, you have the Gaslamp Quarter, Balboa Park, Sea World Area, Old Town, and Coronado Island. In New York, you have Greenwich Village, SoHo, Upper West Side, Upper East Side, TriBeCa, Harlem, Midtown. Then there are submarkets within those areas. Know where you want to be specifically, and start there. You may have to work your way outward or to other submarkets if there is nothing in your first-choice market. (Location 991)
As tempted as you will be to jump on a plane and fly from California to Florida or from Virginia to Texas when you see what looks or sounds like a great deal, stay focused and resolute on your goal. It’s too overwhelming to try to consider everything at once. (Location 996)
Becoming an Expert You need to become an expert in the submarket you select and a good deal of that learning happens during the market evaluation phase. But it also happens as you are evaluating properties. (Location 998)
USE YOUR RESEARCH The research you have done in preparation for property investment should be organized and usable. I have market and property information organized so that I can refer to it at any time. (Location 1004)
The research that you did months ago should be continually updated. Real estate is a fast-moving business, so I do research all the time. Anything that I see that pertains to my target markets I catalogue and keep. Anything that pertains to markets I’m not currently targeting I catalogue and track. (Location 1008)
LOOK AROUND Before you seriously target a property, look hard at the neighborhood. (Location 1019)
You cannot change the neighborhood, so make sure the property is in a place that you’re prepared to manage. (Location 1026)
seller. First, brokers tend to specialize in their markets, so choose one who is a specialist in your target market. If you make a good selection your broker can be a wealth of information to you. (Location 1044)
Second, brokers save you a lot of time. They will be able to find property quickly and present you with choices. Third, brokers can make calls to property owners for you so you can cover more ground. (Location 1046)
After weeks of narrowing your market, defining your submarket, learning everything there is to know, and talking with business leaders in the community, your broker gives you the bad news: There’s nothing for sale that meets your criteria. So now what do you do? Should you move on? Start looking in another part of town? Wait until something suitable comes on the market? Of course not. You simply make a move to buy a property that isn’t technically for sale! (Location 1056)
Often times when a property is listed, it’s too late. By that point, you’re competing with other prospective buyers, and working with a seller who has established a (Location 1059)
purchase price that he or she may want to stick to. (Location 1061)
The issue here is about the real estate and buying it right. It’s not about whether the properly is for sale or not. You’ve heard the saying “everything is for sale, for the right price.” Well, the same is true here. Many of the properties we purchased, all since early 2002 were not listed for sale. They were all acquired by making the first move and contacting the owner. So how do you do that? (Location 1063)
if I can find out that information about your house, you can find it out about any building you are interested in purchasing. That includes the name, address, and phone number of the owner. (Location 1073)
Once you have enough facts about a property, you’ll want to call the owner. This is the best way to find out more about a property and see if the owner would entertain an offer. Making the phone call can be scary at first but not if you are honest from the get-go. There’s no need to tapdance. Just ask the question and be prepared for rejection. (Location 1080)
relationship. There are two kinds of sellers: one trusting and the other untrusting. Some people may give you lots of information and that helps. Others may be secretive and not want to divulge anything. Either way, keep accurate notes of everything stated, because what is stated in this conversation is highly material to any future negotiations. (Location 1153)
CHAPTER SIX ACTION STEPS • Narrow your target property parameters further based on your initial review of properties in your targeted submarket. • Find out everything you can about the properties in your targeted submarket: use your team to help you get specifics on every property create a spreadsheet or chart that compares, at a glance, the rents, features, and amenities • Continue to read the business, government, and news sections of newspapers and recognize how any (Location 1166)
changes can impact real estate. • Find all the real estate associations in your area and join them. Attend their functions and make a point of meeting people. • Decide whether you want a broker to help you find property. • Locate and target a few properties you may be interested in buying. • Find the owner information on the Internet. • Call and meet with residents, shop owners, and property managers to get more information. • Get ready to make your first phone calls (you’ll need the in formation in Chapter Seven to follow up on any properties that may be for sale, so hold off on making your calls!). (Location 1172)
Someone once told me that the average person remembers only three to five concepts in a business book. Just three to five! (Location 1180)
A deal is either good or bad and fortunately a bad one is easy to define. It is simply a deal where the numbers don’t work. In other words it’s when the projected cash flow—income minus total expenses—equals a low or negative number. In good deals the numbers work. In bad deals, they don’t. (Location 1192)
They purchase property based on the seller’s asking price, or something close to it, instead of the operational performance of the property. (Location 1196)
The seller’s asking price is irrelevant. • You determine the property value, which becomes your offer. • With multiple units, the property value is based on the current cash flow of the property. (Location 1198)
That’s because in this chapter, I will walk you through my own personal system for determining property valuations for multiple units. It’s called the Five Step Property Evaluation and I’ve used it for the past fifteen years with outstanding results. Here it is in a nutshell: 1. Verify property income. 2. Verify expenses. 3. Determine net operating (Location 1202)
income. 4. Find the capitalization rate and valuation. 5. Calculate the loan payment and your profit or cash on cash. (Location 1205)
I use those five steps to come up with the initial cash flow for the property and arrive at an offer price. To do that, we look at everything associated with expenses—including our loan payments—and everything associated with income during our analysis. In the end we have a solid picture of the bottom line for the property and are in a position to make our offer. (Location 1207)
be? In real estate investing, return on investment is also called “cash on cash,” and it is your net cash flow as a percentage of your down payment. For instance, if you put $100,000 down on a property and it brings in $1,000 of income per month, your cash on cash is 12 percent per year. Not bad. But if that same property brought in $500 per month, your 6 percent return may not seem worth your time. As you read on, you’ll see why it’s too early to make that judgment. (Location 1213)
Furthermore, the process I will describe in this chapter will enable you to value property without actually doing a physical inspection. You heard me correctly. In over 95 percent of the offers we make, I do (Location 1217)
not visit the community before I complete the valuation and make an offer. What could I really gain by doing a property visit that I couldn’t learn from the seller at this point? (Location 1218)
Don’t misunderstand. I will not buy the property without walking each and every unit, performing a thorough inspection, and verifying the numbers. I just let my team do a lot of the preliminary screening for me. (Location 1224)
My point with these two stories is that offers are nothing more than an opportunity to look at the numbers and make an educated guess about how a property will perform in terms of cash flow, based on a brief, top-line evaluation. As you’ll see in a later chapter, you’ll find out about the property in minute detail once you “tie up” the property by getting it under contract. (Location 1229)
Step 1: Verify Property Income Even if the seller discloses the current income on a rental property either through a pro forma document or verbally, verify it. (Location 1234)
Before we get too far, let’s define some terms. There are three types of income to consider with any property: actual income, actual potential income and future potential income. • Actual income: The total income the property generated in the prior twelve months. • Actual potential income: The total income the property could have generated in the prior twelve months had all units been 100 percent (Location 1239)
occupied and had the owner taken advantage of all other income opportunities. • Future potential income: The total income the property could generate at today’s market rents, 100 percent occupancy, and taking full advantage of all other income opportunities. (Location 1243)
Traditionally, many property owners will try to sell their property based on the future potential income. It is in your best interest to buy it at the actual income. That’s the way I like to buy—based on the way the property is currently running and the amount of money it is currently making. I think of that as “wholesale.” If you buy property based on how it could run and the income it could generate in the future—the future potential income—I call that buying it “retail.” Try to (Location 1246)
avoid retail purchases at all costs. Buying right means buying at wholesale. When you buy wholesale, your mortgage is lower and right out of the gate that means you are maximizing your profitability on the property. (Location 1249)
between retail and wholesale out in the open, trust but verify all numbers listed on the back of the sales brochures you get from brokers and sellers. (Location 1251)
Here’s how you verify the income from the numbers on a typical property pro forma in a sales brochure. The information I’ll use in this example is from an actual property in Phoenix, Arizona. Let’s (Location 1260)
based on the seller’s pro forma, your income would have been more than $6,000 below what you expected. That’s not good. But what if the seller doesn’t reveal the actual rent numbers in the small print on a brochure pro forma, and they usually aren’t. Then you must request a rent roll and use those numbers for your calculations. You should even verify the small print rents on a brochure such as this one by comparing them to the actual rent roll. Trust, but verify. (Location 1281)
Take a look below at what happens to our total income when we insert the real rents in the projected column. (Location 1312)
As I’m sure you have guessed, when I formulate my offer I disregard the other two income numbers and use my own projected figure, the one that takes into account the real property rents. The best part of this strategy is that because the numbers are real, they are easy to defend during the negotiation process. (Location 1321)
Before we leave the topic of income, let’s address future potential income. Recall that future potential income is the total income the property could generate at today’s market rents, 100 percent occupancy, and by taking full advantage of all other income opportunities. You may find through your income verification process that the reported rents are well below the market. This could be your “Advance to Boardwalk” card, so keep it close to your vest. It’s this kind of upside potential that property investors dream about. With income verified, it’s now time to turn our attention to expenses. (Location 1326)
Step 2: Verify Expenses Expenses are the second important variable to consider. (Location 1330)
In most cases you’ll see not only the prior year property tax amounts, but also projections for one or two years out. Focus on the future and use the next year’s assessment as your projection. (Location 1367)
ADJUSTED EXPENSES At this point, we have the numbers we need to complete our analysis. (Location 1383)
Step 3: Determine Net Operating Income After you have determined your income potential for the property and you have a good estimate of the expenses, you need to determine the net operating income (NOI). (Location 1390)
Capitalization Rate = Net Operating Income ÷ Purchase Price (Location 1408)
To determine how much the property is actually worth—in other words the property’s valuation—you just divide the net operating income by the capitalization rate. The number you arrive at is the valuation. It was called purchase price in the previous formula. And the valuation is your initial offer. Property Value and Offer Price = NOI ÷ Capitalization Rate (Location 1414)
So we’ll divide our NOI by our capitalization rate, and in doing so, we arrive at a property value and offer price of $255,926. $22,368 ÷.0874 percent = $255,926 The offer should be no more than $256,000. (Location 1420)
Step 5: Calculate the Loan Payment and Your Profit Cash on Cash Assuming you and the seller agree to the price of $256,000, now is time to figure out what the loan payment might be. (Location 1431)
To calculate cash on cash, divide your profit of $2,358 by the down payment of $25,600. For this deal, your cash on cash return is 9.2 percent. Not a bad return. Cash on Cash = Profit ÷ Down Payment (Location 1441)
Congratulations! If you purchase this property for $256,000 with 10 percent down, your return on investment will be 9.2 percent. (Location 1443)
CHAPTER SEVEN ACTION STEPS • Get on mailing lists to secure several real property proformas to practice the Five Step Property Evaluation process. • Use the numbers on the pro forma to calculate your offer price. • Realize that when you go through these steps for real, you will verify all the numbers on the pro forma with your team members. • Begin making calls to property owners to discuss buying property (Location 1452)
you are interested in. • Perform this valuation process on an actual property with actual data. (Location 1456)
When I know 70 percent of everything there is to know about a property, that’s enough to make a decision. To me 60 percent is too little, and if I wait until I know 90 percent, someone has either already beaten me to the punch or I fall into the trap of never having enough information to make a decision. (Location 1467)
Before we go any further, I want to point out that if after your analysis you don’t think the property is a good investment, in other words, if the net cash flow is too low, then you may need to walk away from the deal or offer a much lower price to make the numbers work. These numbers don’t lie and unless your math is wrong, the estimates you arrived at are factual. It is perfectly okay to walk away, although you may feel like you did a lot of work for nothing. But remember, every step in this process is a learning experience, and with every exercise, every calculation, every building walk-through, you are getting smarter. (Location 1471)
deal. It takes me about thirty minutes to do the Five Step Property Valuation process once I have… (Location 1477)
Should you decide the property still looks like a good idea, you’ll find your high level of preparation will put you in an excellent position for negotiation because you have all the numbers and all the facts. And believe me, numbers and facts take the emotion right out of the process. But let’s be real. There may… (Location 1480)
more than you’ve shown it to actually be; that happens often. But the difference is that armed with the numbers, you are not waltzing into the seller’s office making an arbitrary low-ball offer. Instead, you are coming in with a well-prepared case, based on research and facts,… (Location 1482)
When you feel good about the numbers and arrive at the decision to buy, you have reached a real milestone. In this phase of the process, the goal is to “tie up the property.” What I mean… (Location 1487)
market by beginning the process of generating the letter of intent or in some cases executing a… (Location 1489)
That’s why I try to complete the steps in the last chapter within forty-eight hours of receiving all… (Location 1491)
Remember, the goal is to tie up the property, and during that time,… (Location 1494)
terms of the sale and, equally as important, review the property and its operations in its finest detail. By the time you are done, you may find your offer was too high and needs… (Location 1495)
Don’t worry so much about the vehicle—whether it’s a letter of intent or a standard purchase and sale agreement from the… (Location 1500)
aware of the deal points… (Location 1501)
Letter of… (Location 1502)
Once you’ve established the valuation using the five steps in the last chapter, you are ready to draft the letter of intent or a purchase and sale agreement. I prefer to use a standard letter of intent to map out the deal points between myself and the seller before moving to a formal purchase and sale contract. Letters of intent save me a lot of money in attorney fees because attorneys are not usually involved in letters of intent negotiations. Further, the work done during this process makes the actual contract process smoother and faster. The letter of… (Location 1502)
Sample letters of intent are available on my Web site (www.kenmcelroy.com under “Resources”) and will give you an idea of what these documents look like. (Location 1520)
Purchase and Sale Agreement Once both the buyer and the seller agree upon the terms in the signed letter of intent, you are ready for your attorney to draft up the purchase and sale agreement or you can use a standard form from an (Location 1524)
agency you may be working with. (Location 1526)
later. There is some important language that I make sure is in every contract we sign. That language is as follows: • Purchase price: What is the total price? • Down payment: How much do you need down? • What is the initial deposit to open escrow and start your detailed research? • Who holds the buyer’s deposit in escrow and when does it become nonrefundable? • What are the time frames after the agreement acceptance date especially for contingencies and close of escrow date? • What are the prorations for (Location 1533)
rents, taxes, insurance, security deposits, all of which should be split between the buyer and seller at close of escrow? • When will the title report be delivered and what is in it? • What are the financing contingencies, including getting a new loan or assuming the existing one? • What are the due diligence time frames, including receipt of all books and records, rental agreements, operating statements, rent rolls, personal property inventories, service contracts, utility information, ALTA* survey, environmental reports, building plans, engineering reports, or any recent appraisals? As the buyer, you must receive all of these before the due diligence period begins. • What is the time frame to perform the pest control (Location 1539)
inspections? • What are the time frames for the physical inspections of all interior and exterior spaces, including units and common areas? • Does the seller have any information with regard to lead-based paint or mold and other allergens? (Location 1546)
CHAPTER EIGHT ACTION STEPS • Visit my Web site (www.mccompanies.com) and print out several sample letters of intent and get familiar with the pro visions and language. • Do the same with purchase and sale agreements. • Continue to seek out property prospects, calculate valuation, and when you see a deal with numbers that work, generate a real letter of intent or in some states the purchase and sale agreement. (Location 1577)
The management plan will define the key strategies you will use to either cut expenses, increase income, or both. The operating budget links numbers to those strategies and helps you quantify your bang for the buck. (Location 1717)
Not long ago, we were in due diligence on a property in Tucson, Arizona that was in bad need of repair. There was no way I could estimate the costs of repairs on my own, as they were way beyond the scope of my expertise. So I called in my contractor to do a site inspection (Location 1726)
and asked him what it would take to get the place in shape. He provided me with a rough estimate of $700,000, which we provided the seller. (Location 1728)
You will reach your financial goals much quicker if you can find property that is underperforming and kick it into shape through sound management. (Location 1737)
The property itself should be showing you the money. If you aren’t seeing increased income potential around almost every corner, you’re not looking very hard—or there may not be much. If it’s the latter, you may want to consider another property alternative. (Location 1746)
Here are a few what if’s you should be asking of the properties you are considering: • What if I increase the rents? Will it create more vacancy? How quickly will I rent the unit if someone moves out? Can I test it on vacant units before issuing increases to existing residents? What is the market rent in the area and are my rents in line with the market? • What if I need to attract new residents? Do I have a system in place? Do I have a waiting list if I am full? (Location 1753)
I can’t emphasize enough the importance of putting your property plan on paper and then working your plan. It is not a complicated document. (Location 1818)
The Operating Budget This really sounds much more complicated than it is. In Chapter Seven I taught you how to read a seller’s pro forma and make an offer. The steps to the budget are not all that different. You calculate the property income by using the information you obtained on the income statement, rent survey, rent roll, and operating statements. Then you look at expenses based on the actual and projected expenses you’ve gleaned from the due diligence process. (Location 1827)
Once your analysis is completed, your spreadsheet should look (Location 1838)
something like this: Based on this rent roll, the actual potential income including the vacant unit is $3,492 per month. Use this number as your actual potential income in your budget. (Location 1838)
From the operating statements and individual ledger cards for each resident you should get an idea of what other types of income exist at the property. After all, somebody has to deposit this money into the bank account, so there is a paper trail somewhere. Sometimes this information is difficult to get from the seller. Not everyone is a good bookkeeper. If this is the case with the property you are buying, you will need to re-create the records from the facts you do know. (Location 1848)
A typical management staff, depending on the size of the property, can include several people. First there are the on-site managers and leasing agents. Then there’s the housekeeping staff that assist with unit turnover and upkeep of common areas. There are also maintenance people who complete minor repairs of buildings and grounds. (Location 1864)
Administrative costs include the fees you pay for special professional services such as an attorney to help you establish partnerships and assist you with evictions. Accountants will help you manage accounts receivable and accounts payable as well as guide you through tax laws and tax reporting. (Location 1870)
Check to see if the utilities are individually metered, which means each rental unit has its own meter, or if the utilities are master-metered. If they are master-metered, there is one meter for the entire building. (Location 1903)
Individually metered is the better scenario because the resident pays their own bills. Individually metered buildings mean lower expenses to you. In master-metered buildings there is no incentive for the tenants to keep utility costs down. I stay clear of buildings that are master-metered for this very reason. (Location 1905)
Here is a short reference list of findings I’ve had to confront sellers with in the past; you may find yourself in the same position: • Vacant units listed as occupied on the rent roll. • Notices to vacate or unreported future vacancies. (Location 1939)
You may be amazed to discover that I have never purchased a single property without going through the process described in the last chapters. To me it has just never seemed worth the risk to rely on gut instincts alone. And I certainly do everything in my power to not get emotionally attached to any property. In fact, I go into every (Location 1967)
property deal with the full assumption that I won’t close the sale. (Location 1969)
I know through personal experience and through the stories of hundreds of people who have shared their struggles with me at Rich Dad Seminars, there is no fix, no repair, no advertising strategy that can mend a property that you simply paid too much for. Even improved management practices don’t do the trick. (Location 1972)
Managing the property is about maximizing your cash flow. (Location 1986)
INCREASING THE CASH FLOW It is the property manager’s responsibility to increase the cash (Location 2028)
flow of the property. Good property managers understand the real-world parameters within which they must work to achieve this goal, but if you are managing the property yourself, you’ll want to be aware of what the market is doing in your immediate area. (Location 2029)
You are going to want a limited liability entity like an LLC for asset protection. For a good overview I recommend reading Start Your Own Corporation by Garrett Sutton, Esq. (Location 2041)
There are three basic ways a property manager can be fired. The first way is when the (Location 2142)
property itself does not perform well, especially if the property performs worse than the investor anticipated. A change may be necessary to improve the property operations. The second way to get fired is if the property does not improve its operations year to year or the operations remain the same. No improvement? Well, that is not why we bought the property, is it? Fire ‘em! The third way to get fired is if the property really outperforms the investor’s expectations. The reason for the firing is that management looks easy and a property manager is not needed when a property is doing so well. The investor can do the job and save the fee. (Location 2143)
have to recognize when a property management company should be fired. These are the things I won’t tolerate when it comes to property management: • A company that doesn’t assume a partner mentality and doesn’t communicate to the property owner (Location 2153)
things like market conditions that affect supply and demand. • A company that neglects the physical condition of the property. If the property manager sees a piece of litter on the ground, he or she should not step over it. • A company that has high employee turnover in any area; this makes building a relationship difficult. • A company that has inconsistent or incomplete reporting. (Location 2155)
There is no mystery to the trend that when you take care of your residents they are more likely to renew their leases. (Location 2188)
Maintain a reserve fund that is adequate for your property for when the unexpected happens. (Location 2200)
What I do is look at this condition and flag things like older roofs or appliances that are likely to fail. (Location 2202)
STEPS • Set up your systems for maintenance, accounting, and rent collection. • Investigate hiring a professional property management company and interview several. • Run criminal and credit background checks on every new applicant. • Become involved in local supporting professional affiliations. • Enforce the policies and procedures in the lease, no exceptions! • Respond quickly to your residents with a smile. (Location 2209)
I am a firm believer in buying and holding property. That’s what I do and that’s how you create wealth and cash flow. (Location 2218)
To do that you’ll want your property at 100 percent occupancy, even if it means some of your rents are slightly below market. (Location 2235)
When you are selling your property, you want to demonstrate the highest future potential income for the property, not the highest actual income, because remember, as explained in Chapter Seven, the actual income is the wholesale price, potential income is the retail price. (Location 2238)
To maximize your sale price, you are better off having your market rents high and creating some vacancy. (Location 2246)
Property management companies are a prime source of leads, so you are wise to take advantage of the network. (Location 2289)
Now he is out of his comfort zone. He has had to quickly assemble a team, learn another market, actually multiple markets, visit numerous potential properties, all while working at another job. (Location 2301)
Currently they own over 8,000 units in several states including Arizona, Texas, Nevada, and Oklahoma. (Location 2322)