This is a long post, you may or may not want to read it.
One way to be an owner in a real estate transaction is to simply retain a percentage of the building for doing all of the work, and have another party invest the money. You would then receive a % of the building for the work you put in. Now technically this may or may not be illegal depending on if the person who is invested, is an accredited investor. Next post will be on accredited investors.
So one of my family members is interested in real estate investing, he lives in another state and is considering moving here. So I see the opportunity and he is interested in doing a deal with me. I will put the deal together, do all of the work and receive a cut off a building. The following is a proposal I sent to him, with many typos but he likes the idea, and its not the typos its just a general sum of information about real estate investing. But before I get here, I want to stop and take a look at one philosophy.
In order for it to work, you either need alot of one commitment: ie: a lot of money, or a lot of time, or if you have a little bit of both you can make it happen and make some money on investments.
So this idea, and this propsal Im showing you that I wrote out for a family is someone coming from me having skill and time to invest, and the other party having money. In this case, once the deal is complete I will technically be owning part of a building with no money down, but I did put something down, I put down my skill and time.
The following is the letter I send to my family member, names of the other party have been removed for privacy, but you can see what the heck wes mahler is doing with real estate investing.
Hey John Doe,
Here are some thoughts I have jotted down on this letter. Please realize I havenâ€™t gone through and proof-read everything. So I apologize in advance for things that donâ€™t make sense, Iâ€™ve never facilitated a real estate deal for someone else as of yet, (although have been trying to do that for 5 months now). So I created this document while you were here, and finished it today. It is some just notes on the transaction, what types of returns, how long it would take, the money required, what it would cost, and how it would sort of all play out. This should be a good start into the real estate investing into Portland deal. Again, not the most professional paper here, but it should get the job done.
You can call me at anytime on my cell at xxx.xxx.xxxx.
Real Estate Investment for John Doe
Idea: To facilitate a real estate investment in Portland, OR for John Doe through purchasing a residential rental property, 4 units or less and managing it for a long-term investment. Property would be located in inner Portland, it would be 4 units or less, and be nice enough to be a potential place for John Doe to move in-to at a further date if necessary.
Investment: The investment on the building would be 10% down, the investment can go up or own depending on the sales price of the building. The estimated sale price on a building that may be of interest to us, a single family house or duplex, will be approximately in the range $200,000 â€“ $250,000. $250,000 would be on the higher end, this would be located in the inner Portland district, and have at least 2 bedrooms 1 bath per unit, preferably one unit with more bedrooms for John Doe if he decides to move in at a later date. With the proposed sales price, which is based off a rough estimate of the median sales price for what we are looking for, it will be approximately at $20,000-$25,000 investment for a down payment.
Although there would be additional costs in purchasing a building, the down payment would be the bulk of the money. There will be some closing costs associated with closing on the property, estimated around 2% of the sales price, so on the estimated sale price on an investment it would be fair to estimate around $4,000 in closing costs. Now of course we would most likely be negotiating with the seller and have them contribute the money towards the closing cost in negotiation.
Additional fees and services would be minimal, there would be a home inspection, which will be around $250-$400 to have someone come in and inspect the foundation. If there is an oil tank on the property it will be an additional $150 roughly to inspect for an oil tank leaks, the only other inspection that would potentially really be necessary would be a sewer inspection, other than that, theses inspections would be the cost on doing the due diligence on the property.
The rest of the remaining cost would be associated with general maintenance, although we would do our best to find a property that is a rock solid investment, and do our due diligence to make sure no work is needed any time soon, and if needed, we have the seller pay for the repairs before we purchase.
How it could be put together
The real estate transaction could be put together in several months; the proposed time from starting to finish (closing on the property) would approximately take around 4 months as a rough estimate. The two (2) weeks would be spent getting all of the lending requirements done, getting pre-qualified for a â€œresidential investment property loan at 10% down.â€ Once we had pre-qualification and a good faith estimate on what the monthly payments would be and percentages, we could then start to look at properties and run numbers to make sure they fit the right parameters necessary to make a good investment.
Finding a property could take considerable time, much of it would be determined by the current market conditions. Currently today (August 2007) it is a good time to purchase real estate because it is a buyerâ€™s market, from what I know a buyerâ€™s market is when real estate is sitting on the market for more than 6 months. There is plenty of real estate for sale and there are many properties that could fit our investment parameters.
Finding a building, I (Wes Mahler) would be working with my realtor, who is a real estate investor themselves and would locate a building that would make sense on the numbers. We would determine the net operating income (the rental income, minus vacancy loss, minus property tax, minus insurance, minus maintenance, minus utilities, and minus and property managers) and then only purchase a property where our NOI (net operating income) is equal to, or greater than out monthly mortgage payments. In short, we would only buy an investment that would at least break even on the cash flow (even with vacancy, maintenance, and everything factored in) or find something that is positive cash flow even after maintenance. We would do our best to get it right on, unfortunately because the housing prices are going up; it has been becoming increasingly difficult to find a property with 10% down to break even or cash flow, so it will be most likely that the property investment will be breaking even.
So finding a property would take time, estimate around 1-2 months in order to find a good property worth investing in. After that we would proceed on making offers on the building, we would be making offers on several buildings, lower offers, get rejected a couple of times and make sure we are getting a good deal when we buy. My philosophy is, if they accept your offer, we are paying too much for the building. So we offer a little less, get rejected a couple of times to find a better deal, with a motivated seller.
Making offers and running through negotiations should take around a month in time, we will probably get accepted on several offers and then run the due diligence on them, due diligence will take approximately 2 weeks in order to complete. Some buildings will fail the due diligence process so we will be looking at several properties and being very selective on what we buy. We are not needy or emotionally attached to any deals, we just look at the numbers and the numbers will tell us what to do.
We will run through the several inspections as mentioned above, and once we find a property then we will begin to close. Closing will take approximately one week, and it will require the owner of the property to be around to do the signings, unless a power of attorney is used to allow someone else to act in his or her name. Regardless of what route is chosen, closing is fairly easy, at this time, we have already spent money on due diligence (paying inspectors) and at this time will be simply providing the down payment for the property, which will included payments for the taxes and insurance for each year.
At time of closing then the property would need to get rented, we would be able to put the property on craigslist and rent the property out immediately upon closing. We have the documents and contracts necessary for doing the rental applications and would be able to get the properties filled. We understand that we donâ€™t want any one, and that it is better to have no one renting the property than a bad person renting the property from us.
Management would be full-awareness task, not necessarily full-time, but full time available in the incident that someone is needed over at the property. It could be done two ways, that either I would be able to manage the building, or finding a company that could manage it for you that would still produce a break-even monthly cash flow or better.
In the time that a large repair needed to be made we will work together in order to fix the problem, if we do it correctly we should have bugged in expected maintenance into our cash flow equation.
At the end of each year taxes and accounting work will need to be done. We will our accountant go ahead and work on the tax filings, what would probably happen is we would place the real estate asset into an LLC (limited liability company) because it is one of the best entities for real estate investments due to the accessibility of the cash flow and relatively ease to set it up and operate it. The costs associated with starting an LLC would be approximately $100/year for the entity, and having the accounting do the work would cost approximately around $500-$700/year depending on how complicated the finances are.
What the returns might be
If we take the above proposed example of investing in a building around $200,000 I can give some rough estimates on the return on investment.
Â· 10% down payment
Â· $20,000 down to control $200,000 worth of real estate.
For the last 5 years Portland has appreciated about 13% each year, although it wouldnâ€™t be surprising if it continued to appreciate by around 10% each year, letâ€™s just say conservatively it appreciated 5% the near year.
During the 1st year, with a 5% appreciation figure, your building would now be worth $210,000.
There is now an extra $10,000 worth of equity due to appreciation growth.
With in respect to appreciation, your $20,000 investment just earned $10,000 in equity appreciation, a 50% ROI in 1 year with just appreciation figure.
With amortization on a $200,000 year loan, taking into consideration that the first payments are more interest heavy, that is they are primarily more interest than paying down the principal. It is safe to assume the mortgage is paying down approximately $150/month on principal in the first year. This would result in amortizing the loan around $1,300 for the 1st year.
The cash flow from the rent would be breaking even, although, we would have a considerable tax deduction by writing off the depreciation of the building, potentially carrying over to another tax return.
What it might cost to put it together
I wasnâ€™t exactly sure how much to do the deal for, so it took awhile to figure it out.
The proposed plan would be doing all of the work, everything, from helping setup the finances for the loan, to finding the building, to analyzing buildings, make offers on the buildings, due the due diligence on the building, closing on the buildings, forming the LLC, advertising the property go get it fill, managing the property, getting the accounting done, and filing the necessary tax returns at the end of the year for the LLC, and of course be available 24/7 incase on site assistance is needed at the property.
I came to the conclusion that it would work at a 20% for putting everything today.
Well, I also must clarify what the 20% of it means, it would just means for instance, that if we invested $10,000. For putting together everything and managing it, my â€˜workâ€™ equity would have interest in $2,000 of the down payment.
So if we purchased a $100,000 building with $10,000 down. (Our equity in the building would only be 10k, because the mortgage would be $90,000). I would ask for 20% basically of the equity in the building that we owned. I hope that makes sense, it is basically like me getting interest in 20% of the down payment for the work that I would be putting into the transaction.
Here is why I figured 20%, I was thinking 10% would be too low because for instance, if we purchased a $200,000 building with 10%, or $20,000 down. If I was to get 10%, Iâ€™d only have $2,000 at the start.
If the building appreciated 10% in one year, resulting in our building being worth $220,000, our equity in the building would now be, $40,000 (our original down payment + appreciation equity). If I was at 10%, that means after 1 year of appreciation growth (while I was managing the whole time) I would have earned an extra $2,000 for one years of work. $2,000 in one year of managing a property when I looked at it like that was just not enough money; it would be less than minimum wage for a whole month of working at McDonalds.
I came to conclusion that 10% is just not worth it for me, and 20% would make it worthwhile for me to put in a significant time investing and you would still make a large return on investment. If for example in the above situation, if the building appreciated 10%, and you put 10% down on a building, you would have earned $8,000 in one year, off a $10,000 investment. Or a 80% ROI (if our building went up 10%, and we put down 10%). Hope that makes sense.
The 20% would be a lot higher than a stock broker would charge on a commission for a stock transaction, but this is completely different. Whereas a stock broker can get a commission for a buy recommendation or whatever, Iâ€™m going to be putting in many hours of work, running around, negotiating with sellers, working with mortgage brokers, on call, a long-term residual person who works for you throughout the whole deal, Iâ€™m going to be doing 100x the work of a stock broker, and Iâ€™m going to make more money than the stock broker can be.
Real Estate Vs. Stocks
Here is why I donâ€™t like stocks.
If a stock plummets to $0/share you are screwed, if your building burns down you have insurance.
If you want to liquid your stocks you have no real way of avoiding capital gains, with real estate you can defer your capital gains by doing a 1031, and pay NO capital gains on your real estate appreciation.
With stocks you always have to buy a stock at what its current value is, with real estate you can buy a house less than the appraised value and immediately have equity in your pocket. In other words, with real estate, you can make money immediately when you buy it right. In stocks, you canâ€™t do that.
In stocks there is practically no leverage in the portfolio, (unless you do some sort of risky options). But if you have $10,000 in stocks, and you get 10%, thatâ€™s not that great. Whereas in real estate, with $10,000 as a down payment, u can control $100,000 worth of real estate, and get a 10% ROI on the $100,000.
If you got a 10% return on $10,000 in stocks, you would have made $1,000 in a year. You would have only made a 10% ROI on your 10k.
If you got a 10% return on a $100,000 building, you would have made $10,000 in a year, or a 100% ROI on your 10k.
Then there are also no every year tax benefits to holding stocks, but there is in real estate. Every year you can deduct the depreciation of the building, and the expenses, and mortgage interest off of your taxes, you can dramatically reduce the taxes you pay every year just by owning a building.
The banks will loan you most of the money you need to buy real estate, letâ€™s try asking a bank to loan us money because we heard of a great new stock tip. Not happening.
With real estate you can make your building be more valuable with sweat equity, with a stock, there is almost nothing you can do to increase its value.
In real estate, you do not even have to sell your property to get the money out of it, like you are familiar with you can always put up equity as a line of credit or re-financing your mortgage. With stocks you are forced to sell and pay capital gains.
With real estate, they are not making any more land, as population continues to rise, most of real estate in specific places will continue to rise.
As the economy gets worse and more people lose their home, and as the depression come, there will be more renters, and renting demand is increasing and the price to purchase a home is going up.