Calculations from an actual investment purchase

In this third and final part of Real Estate Investing Basics, we will evaluate an actual buy and hold deal we purchased. The property is a 4 bedroom home in Oceanside, CA, 92056. It was real estate owned after a foreclosure and had been sitting on the market for 240 days. It was purchased in January 2012 for $330,000.

The most critical metrics we used when we evaluated this deal:

  • Cash flow = $367 / month. We try to get a minimum of $200 per unit.
  • Capitalization Rate = 5.5%. For a nice single-family residence (SFR) in Oceanside, I accept CAP Rates greater than 5%.
  • Cash on Cash Returns = 5.8%. I compare this number to what I could get in the stock market or from another investment. For a San Diego SFR I accept greater than 5%. I may be able to get more from trust deed investing or stocks, but I like that someone else is paying down my mortgage, I am leveraging my money with a loan, I am getting tax benefits, and I have control of my asset.

The actual detailed numbers to get the calculations:

REI-BLOG-Calcs-Formatted

Download the Excel spreadsheet to do your own calculations.

Real estate is a great investment opportunity and with the right research and property managers, you can do it part time and passively with little stress! If you are interested in self-improvement, passive income, financial freedom, entrepreneurism, or real estate investing, take a look at a few useful resources that I have noted below.

Beginning books:

  • Rich Dad Poor Dad by Robert Kiyosaki
    • I lovingly refer to this book as the gateway drug for people who are interested in investing or working for themselves. If this book doesn’t get you psyched up to achieve financial freedom I don’t know what will!
  • The 4-Hour Work-Week By Timothy Ferriss
    • This book is good for efficiency enthusiasts or entrepreneurs who want to optimize their lives or businesses.

Next level books:

  • How to Win Friends and Influence People by Dale Carnegie
    • This book is great for anyone who interacts with people and wants to get better at it. It can help a lot in your personal relationships and teach you how to get people to like and trust you (which helps immensely with sales).
  • The Millionaire Real Estate Investor by Gary Keller
    • This book was written by the co-founder of Keller Williams. It has slightly more technical investing information (compared to Rich Dad Poor Dad) and is still is very inspirational.
  • Cashflow Quadrant by Robert Kiyosaki
    • Another inspiring book that is written for people who want to escape a 9 to 5 job and move into a life where they work for themselves as an investor, entrepreneur, and/or business owner!

Online resources:

  • BiggerPockets.com
    • An online community for real estate investors, professionals, landlords, property managers, etc.
  • NOLO.com
    • A good website for general information about starting a business, investing, tax tips, etc.
  • MortgageCalculator.org
    • A site to help you calculate monthly mortgage payments.

 

How to evaluate rental properties

In part one of Real Estate Investing Basics, I reviewed some simple reasons why real estate can be a great investment. But how do you determine which properties are the best buy and hold investments? I suggest learning the concepts, terminology, and metrics (calculations) to compare properties. Here is a quick explanation of definitions and metrics that summarize some of the basics of real estate investing (REI).

Definitions

  • Gross Income: All income received from an investment, rents, and other (subtract vacancy costs and collection loses).
  • Operating Expenses: All recurring expenses from an investment.
    • Includes: insurance, taxes, HOA fees, maintenance, repairs, property management fees, etc.
    • Does not include: loan principal and interest, income taxes, capital improvements, depreciation
  • Net Operating Income (NOI): Net operating income is the actual income stream from the property after you subtract operating expenses.
    • NOI = Gross income – Operating expense
  • Cash Flow: This is a measurement of the profit or loss from a property for ALL money in and out.
    • Cashflow = All income – All expenses

Below are very simple metrics for qualifying the investment of multiple properties:

Monthly Percent Rule (AKA 1% Rule or 2% Rule)

  • This metric is a quick and simple rule of thumb for evaluating properties before putting a lot of effort into an in-depth analysis. It is a ratio of the monthly rent to the total sales price and rehab of the property.
  • % Rule = (monthly rent / total sale price + other costs to ready the property for rent) * 100
  • For example, if you bought a property that cost $180,000 + $20,000 for rehab and it would rent for $2,000 per month = ($2,000 / $200,000 ) * 100 = 1%

Yearly Percent Rule

  • This metric is similar to the monthly percentage rule but it is the ratio between the yearly rent and the total sales price and rehab of the property.
  • Yearly % Rule = (yearly rent / total sale price + other costs to ready the property for rent)
  • From the same property example above = ($2,000 * 12 / $200,000) = 12%

Below are more advanced metrics for analyzing properties in more detail:

Capitalization (CAP) Rate %

  • The CAP Rate is the rate of return on an investment based on expected income. This calculation intentionally does NOT include mortgage payments as a cost in this calculation. Loan payments vary by the type, duration and terms of loan. Removing these from the calculation allows you to compare properties using an unbiased, apples to apples comparison.
  • CAP Rate = ((Net Operating Income / Property Value) * 100)
  • For example, if you were looking at a duplex that would cost $300,000 to buy and rehab, and it produced a net income of $30,000 per year, the Capitalization (CAP) Rate would be: CAP RATE = ($30,000 / $300,000) * 100 = 10%.
  • You can get more information about CAP Rates at PropertyMetrics.com.

Cash On Cash (COC) Returns

  • Cash on cash returns is a simple and effective metric to calculate your return on investment (ROI). It DOES include mortgage payments. It is a percentage that shows the ratio of annual income to the original amount of money invested. The initial amount of money invested is not necessarily only the sale price but it also includes the costs to purchase and rehab the property.
  • COC Returns % = ((Annual cash flow / Amount invested in property) * 100)
  • For example if you bought a $400,000 property for 20% down ($80,000) and then invested $20,000 in repairs, the initial investment of cash would be $100,000. If the property produced a total positive cash flow of $10,000 per year the calculation would be:
  • COC%= (($10,000 / ($80,000 + $20,000)) * 100) = 10%
  • Check out RyanPrice.ca for more information on how to calculate cash flow.

On the surface, evaluating profitability on buy and hold properties is not extremely complicated. There are many other critical factors that must be taken into consideration such as overall market outlook, financing, property inspections, finding the right renters, exit strategies, and more. It is extremely important to do your due diligence on the market, area, property, and people you are doing business with. At Feel Good Property Management, we can help you find the right property, fill it with the right renters, and maintain it to protect your investment.

Check back soon for part three of Real Estate Investment Basics where I’ll break down the profitability of an actual investment property in San Diego County.

Article by Matthew Burch, Feel Good Property Management Client Relations and Agent

Why is real estate a great investment vehicle?

Are you interested in investing in real estate? Do you want to learn more about how it is done and different tools to buy and hold the right properties? You have come to the right place! This three part series simplifies why real estate can be a great investment vehicle, what tools you can use to start buying and managing properties, and shows an actual investment example with calculations.

Real estate can be a great investment if you educate yourself and find the right property. The old real estate investment saying is “You make your money when you buy,” so make sure you do your homework and get the best deal out there! There are many good reasons to purchase and hold real estate. I have summarized four main points below:

  1. Real estate can be an asset that produces a positive income with little work required to maintain and operate it, especially if you hire a great rental management company like Feel Good Property Management. This monthly income is also known as passive income. My family has set a goal to buy enough real estate and other cash producing assets to cover our yearly expenses. When our passive income is more than our living costs, we have achieved our goal of “financial freedom!”
  2. You can use banks’ money and government programs to get money to invest.
    1. A loan can be good or bad depending on your current situation, the loan terms (type of loan, interest rate, term, etc.), and overall financial goals. By leveraging (borrowing) money from banks, you spread some of the risk to them. If the bank loans you $80,000 for a $100,000 property, and the property value rises and you sell it for $150,000, you keep the profit! If the value decreases to $50,000 you are on the hook for $20,000 but at least you have not taken a hit of $50,000.
    2. In addition, by purchasing real estate with a fixed low interest rate loan, you have a hedge against inflation. As the government prints more money, the dollar has less purchasing power, inflation rises, and property values increase meaning it will require more dollars to purchase the same property in the future.
    3. Some people, such as Rich Dad Poor Dad author Robert Kiyosaki, warn against keeping long term debt in place because of how much interest you pay to the bank. Some people preach that you should leverage (borrow) as much money as possible and have the bank take most of the risk. This also allows you to purchase more properties.
    4. My preference lies somewhere in the middle. I am happy with accumulating moderate amounts of good debt (low and fixed interest rate) but I want to avoid bad debt (high and variable interest rate). I also want to make sure I keep enough reserves (liquid cash on hand) in case of emergency such as a natural disaster, tenant eviction, repairs, etc.
  3. Real estate investments have tax benefits that allow you to shelter your income and defer paying taxes.
    1. As a homeowner living in your primary residence, you can write off mortgage interest, property tax, mortgage closing costs (points), home improvements, and more.
    2. For rental properties, you can write off all of the above plus any other costs associated with the property including insurance, travel, home office, depreciation, and more. Check out this article on NOLO for top ten tax deductions for landlords for more information.
    3. Another interesting tax benefit for buying and selling rental properties is tax free exchanges. Simply put, you can sell your current rental property for a profit and avoid paying taxes on the profit by investing that money in a more expensive and lucrative investment property.
  4. Real estate can be an appreciating asset.
    1. Appreciation is an increase in the value of an asset over time. The population is growing and that adds to more demand for housing. If demand for housing outpaces building new homes, home values generally go up. In general, new building and development is currently not keeping pace with population growth and real estate demand. This concept is known as supply and demand.
    2. Beware, property can also depreciate in value as well. The chart below shows an estimate for San Diego home prices from 1987-2014. Over the long term you can see a general upwards trend (appreciation) but you can also see steep a downward trend (depreciation) during the bubble and recession of 2006-2011.
SDTrend

Source: http://www.jparsons.net/housingbubble/san_diego.html

I hope this quick and simplified introduction demonstrates some benefits of real estate as an investment vehicle. I personally like real estate as an asset for the reasons stated above and because people will always need a place to live, eat, sleep, shop, etc. This article is focusing on simple buy and hold investing, but the real estate industry is multi-faceted and there are many other types of real estate investments out there including wholesaling, fix and flip, buy and hold, trust deeds, notes, commercial property, lending, etc.

Stay tuned for part two of Real Estate Investing Basics where I’ll break down definitions and metrics for understanding how to determine what properties are the best for buy and hold investments.

Article by Matthew Burch, Feel Good Property Management Client Relations and Agent

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So the time has come for you to hire a professional to help you find a new house, sell your current home, or manage your investment rentals. Now what? If you don’t already have a good working relationship with a real estate professional, agent, or broker, then you’ve probably found yourself at the whim of Google, Yelp, or your mom’s hairdresser’s best friend’s cousin (and let’s face it, the last option has just one too many apostrophes to even consider a reliable source).

Being in real estate nearly a decade (which really isn’t that long considering some of my wiser counterparts), I come across this question quite often: How do I choose a real estate professional? There are so many factors to consider and facing the market for the first time can be very overwhelming (the jargon alone gets me every time… and I work here).

Below are my “go to” answers for my father-in-law, best friend in Louisiana, and even your mom’s hairdresser’s best friend’s cousin regarding “How to Choose a Real Estate Professional” – from one Real Estate Broker to you:

  • Get to Know Your Area
    Who is working in your neighborhood? Who is managing in your area? Who is selling houses? Call and talk to those agents. Find out their price and what services they offer for their fee. What’s your gut instinct when first talking with them?
    A lot of neighborhoods have niches and certain agents know who is buying, who is selling, and who is renting in your area. I am a huge fan of having fun and getting along with your professional. An agent might be good at closing deals, but your experience might suffer if you can’t understand them or can’t get a hold of them.
    I am a Realtor member, but I can’t ignore the value of the Zillow agent pages in your local area. It’s helpful for the general public to read and get a feel for who is working in your area. You can find it here: http://www.zillow.com/agent-finder/real-estate-agent-reviews/
  • Ask Questions
    Remember, you are interviewing them for a job. Don’t let them ask all the questions. Make a list of things that are important to you. How long have they lived in the area? How long have they worked as a Real Estate Professional? How long have they been at their current office? Do they work as a Real Estate Professional full time or part time? How many listings do they have? How many escrows have they closed? Do they have an assistant or will you be working directly with them? Ask them what they know about your house, your street, or your neighborhood. Whatever questions you have, ask them!
    The answers to these questions will be valuable to you and you can assess the information to help you choose and hire the right professional for you. Don’t be afraid to tell them you are interviewing other agents to find the right fit for you. It takes all sorts of personalities to make the world go around.
  • Get Reliable, Trusted Sources
    Who does your professional work for? Are you hiring an agent who works for a broker or are you hiring the broker directly? How closely will the broker be monitoring the activities of their agent? Make sure you know who you are working with and who they are working under. Accountability is key in any industry.
    Before you sign, verify their license status at the California Bureau of Real Estate website.
    You can also find a member of your local Realtor board by checking the California Association of Realtors website.

In closing, sometimes the new professional in town will work harder for you than the one who has been working the market longer. Don’t discount a newer agent or broker because of their lack of longevity. Just make sure you do your homework and know what you are getting when you hire them. Also, don’t be afraid to work with a small broker office. Or the other side of the coin; an agent in a bigger firm. If you still have questions, I would be happy to help, shoot me an email: bethany@feelgoodpm.com

Article by Bethany Luchetta, Feel Good Property Management Broker

 

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California is in a severe drought, 2011 to 2014 was the driest three-year period since record keeping began in 1895. What does it mean to you, your family, and your real estate? By implementing some simple solutions, you can help save our natural resources, reduce your property management headaches, and potentially put more money in your pocket at the end of the year.

One of the primary ways to enhance your water saving efforts is with drought-tolerant landscaping. According to the City of San Diego, outdoor irrigation accounts for more than 50% of residential water use.

The core premise behind drought-tolerant landscaping is reducing your water usage by implementing simple and smart strategies. Simply put, these strategies include what you use to cover the ground, which plants you choose, and how you deliver water to your plants. These principals go into some detail behind how you can make your landscape more water conscious while minimizing cost and boosting your property’s curb appeal.

Ground Cover

In general, eliminating or minimizing grass will provide huge water savings. If you pay for your (or your tenant’s) water, this potentially means a big cost savings. Grass is a huge consumer of water and probably the biggest source of outdoor water waste. If you want to keep some natural grass, it would be wise to minimize it where possible and ensure you are using high efficiency sprinklers. In addition, make sure you are watering at the correct time of day.

Looking for grass alternatives? Some options include artificial turf, mulch, or other ground cover. Artificial turf has come a long way and can be a big bonus to owners and renters who want a low maintenance yard. In addition, high quality turfs have a great look and feel with many different options that are designed to simulate real grass look. We installed turf at a rental property in Oceanside and had great results. We recommend San Diego Lawns & Turf Company for a wide turf selection and excellent installment.

San Diego County occasionally offers rebates for grass removal. Be sure to check out the WaterSmart website for information regarding potential rebates and savings.

Mulch, decomposed granite (also known as “DG”), and other ground covers are also excellent options because they can be aesthetically pleasing and also conserve water by reducing evaporation from the soil. In addition to reducing evaporation, mulch also reduces weeds and helps maintain more moderate and controlled soil temperatures. Affordable mulch can be purchased at the El Corazon Compost Facility in Oceanside.

Choose Native and Drought-Tolerant Plants

Artificial turf, mulch, and other types of ground covers are great but it can be difficult to attract good renters without the curb appeal of plants, shrubs, and trees. As property managers, we suggest finding local, drought-tolerant plants to complete your yard’s new look! There are a wide variety of succulents, shrubs, and trees that do not require intensive watering.

Leucadia Succulents in Encinitas has a great selection of plants. Another tip for succulents is propagating more succulents from existing plants. Succulents have the ability to be split and multiply into more plants! Check out this video and article for more information on how to do your own succulent clippings.

Water Your Plants Efficiently

How and when you apply water to your plants is a critical component of your smart-scaping. If you want grass in Southern California, it may be wise to invest in efficient sprinkler heads. This will help save water and hopefully motivate your renters to keep the grass alive with moderate watering.

What is the best way to water your other plants? Drip irrigation! Drip irrigation is a low pressure and low flow system that greatly reduces water waste. Drip irrigation applies water to the point of use (the plants roots) and waters plants slowly to allow the soil to absorb the water and avoid excess runoff. Be sure to check out San Diego’s website for potential rebate programs for installing micro-irrigation systems.

Make sure your water controller is set to water at the correct time and day. It’s best to water in between sunset and sunrise because temperatures and wind are generally the lowest. Make sure that you are watering on the correct day by looking at the watering schedules at the City of San Diego’s Water Prohibitions page.
Are you a techie? Look into smart irrigation controllers that account for plant types, soil conditions, and changing weather! Check for potential rebates on these devices at SoCal Water$mart.

Final Thoughts

How does drought-tolerant landscaping affect your real estate? In general, creating a drought-tolerant landscape can boost your property curb appeal and value. In addition, you may be able to find rebates to help pay for the improvements. For homeowners living in their primary residence, implementing these actions can provide huge monthly savings on your water bill.

For owners with investment properties, the actions you choose to implement may be evaluated on a case-by-case basis. These improvements can reduce gardening and water costs, which is a big savings if you are paying those expenses. It can also minimize your landlord headaches by helping keep your rental property looking good through the summer months because your tenants will be less tempted to turn off the water in order to save on their monthly bill.

At Feel Good Property Management, we believe it is equally important to remember the impact that saving water has on the environment. Reducing water usage from your landscaping can help save California’s limited natural resources. By keeping this concept in mind, we can all chip in to keep California a viable and amazing place to live now and for our future generations.

Article by Matthew Burch, Feel Good Property Management Client Relations and Agent

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Becoming a Landlord – Opportunity or Nightmare?

Nightmare landlord stories can be heard on every street corner these days. Your uncle rented to his neighbors daughter, she sublet to her sister who ended up breeding dogs in the house. A few months later they all stopped paying rent. Once he finally got them out, the house was trashed and he lost three months rent, plus he was in over his head with repairs. Your boss rented to his best friends son. The son promptly stopped paying rent, claiming the property was not habitable because of mold in the kitchen. Your boss nearly lost the house to foreclosure because he wasn’t getting the rent. The stories go on-and-on; you probably have a good one too. So how do you protect yourself? You’ve crunched the numbers, made an offer, went through a vigorous escrow process, and got writers’ cramp signing all your documents. You are now an investment owner, a “landlord” … Now how do you survive when there are so many laws to follow and most in California are written to protect your tenant, not you, as the landlord.

Here are a few things to consider when purchasing and maintaining an investment property:

  • Know the Neighborhood
    Get familiar with where you are purchasing. What is your fair market rent? Renting in the right price range will pull in more solid tenants than renting too low or too high.
    Try using Rentometer or asking neighbors what they are paying and make adjustments. Do your homework.
  • Know the Property
    Does the property have any issues? What maintenance issues may arise? Be pro-active instead of reactive. Make sure to review that buyer’s inspection report you paid for. Where there any red flags in the report? Were they addressed? Read all the notes. If done properly, the report is your best friend. Check out a sample report here.
    You don’t have a good inspector? Call Mike.
    Was your rental built prior to 1978? If yes, has it been LEAD tested? Make sure any work you have done on the property is in compliance with the Safe Lead Renovator Law. As a property owner, you can receive fines of $37,500 per day if you aren’t careful. Get information about lead certification here. 
  • Know the Law
    Research your city, state, and federal habitability and landlord rules. How often can you “disturb” or visit your property once tenants are occupying the home? How do you properly serve a rent increase, notice of changes to their lease, or ask them to move. The California Department of Consumer Affairs is a great resource for dealing with problems.
    What can, and can’t, you do when marketing your property, processing, and application, or even writing your lease? Learn about Fair Housing laws here.
    How do you pull credit and abide by Fair Credit Reporting Act?
    The San Diego Apartment Association can assist private owners in pulling credit.

When all else fails, when you start running your costs in buying investment property, build in your property management fee, and contact us.

Article by Bethany Luchetta, Feel Good Property Management Broker

 

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