Increasing Cash On Cash Return For Rental Investments


Lately I’ve been dabbling the numbers to maximize the cash on cash return for rental properties. I’m interested in helping others, as well as myself, acquire properties in the Houston area to build wealth, and maximize investment.

I’ve put together a sample deal to explain how to maximize your returns when financing real estate. The goal of this post is to educate buyers on how to increase their returns on their money. I’m also going to prove why real estate is a better investment than the stock market.

Since 2011, the stock market has returned on average a return of 8.3%. Since 1990, the stock market has returned on average a return of 9.4%. Inflation is sitting around 2% annually right now, so realistically you’re getting around 6%, on average, in the stock market.

Here is my sample real estate deal. This is one I’ve found in the Houston area:

Purchase Price: $47,000
Repairs: $5,000
All in: $52,000

Rental rate: $900 / mo – $10,800 / yr
Cash flow: $450 / mo – $5,400 / yr (financed)

CONVENTIONAL – 25% DOWN
Down payment: $11,750
Repairs: $5,000
Closing Cost: $750
Inspection: $300
Total Expenses: $17,800

Cash on cash return: $5,400 / $17,800 = 30%

CASH PURCHASE
Purchase: $47,000
Repairs: $5,000
Closing Cost: $750
Inspection: $300
Total Expenses: $53,050

Cash on cash return: $8,640 / $53,050 = 16.28%

HARD MONEY > REFI 30 YR
Origination: $1,560
Appraisal: $500
Inspection: $300
Closing Cost A-B: $750
Closing Cost B-C: $0
Total Expenses: $3,110

Cash on cash return: $5,400 / $3,110 = 173%

If you notice my last analysis, the hard money to 30 year conventional, I paid 3% for loan origination, and closing cost twice. This is due to having to refinance into a conventional 30 yr mortgage. Note: this can only be done on specific deals that have substantial amounts of equity. Typical HML lenders require 70% LTV.

Also, I did not include closing cost from the B-C closing due to you should be able to negotiate a $0 closing cost if you refinance and let your HML hold the 30 yr note. They are making thousands off the note, they should waive the fees up front. If not, adjust for that in your numbers as well.

Great returns here in the Houston area.. As you can see, leverage is critical in real estate investing. This is how you maximize your investment.

Happy investing

The Rules of Thumb for Landlording


This is going to be a short post today for a short concept, The 1% Rule of Thumb.

The 1% Rule of Thumb was invented by real estate investors to sift through piles of houses. This rule of thumb will quickly determine if the deal is good enough to make you some money (cash flow) or at least break even.

Keep this in mind: all markets are different. In my market, 1% of the appraisal value for Houston is good for rent. Some markets can get up to 2% of appraisal value in rent. You won’t see that happening in Houston.. because its cheaper to own than rent in Houston!

Do not confuse appraisal value with purchase price/repairs!

 Lets break this deal down real fast:

  • Purchase Price: $65,000
  • Repairs: $32,000
  • Total all in: $94,000

The 1% rule of thumb on the “total all in” cost would be $940 per month in rent. I could get that easily. I would probably have too many applications to even review for that house. I wouldn’t cash flow much at all, but I could get that in rent.

Now I bought the house for $65,000 and put $32,000 in. We’ve found that were $94,000 all in. But here is the kicker..

The house appraised for $137,000.

1% of appraisal value – $137,000 = $1,370 per month in rent.

So now we know the difference between the 1% rule of thumb on appraisal value / purchase price.. but what about a rule of thumb for PITI?

Estimate 50% of your collected rents will go towards PITI, vacancy, property management, and maintenance. So really, you should profit 50% of what you collect in rent per month.

So a quick snapshot on landlord rules of thumb:

Appraisal value: $137,000 x 1% = $1,370 per month

50% rule = $685 cash flow per month.

Although it’s not going to be like that every month, I’d say it’s within $15 of what is actually performing on that property for me.

If you can learn these basic rules of thumb, your life as a real estate investor will be much easier.

Merry Christmas!

How to Analyze & Purchase a Multi-Family Complex


I am working with more and more investors lately, and it seems that they are all interested in a very hot item right now: multi-family complexes.

If you ask any seasoned real state investor, they will tell you that they would rather own a complex of 4 units, rather than 4 single family homes. It makes logical sense, due to the fact it is easier to manage, you have 1/4th the maintenance, and you have one location.

I’ve worked with investors who buy multi-family properties and have great innovative strategies, such as maximizing by renting “per room”, instead of renting “per unit”. This works best in areas where students are living near by, and want to rent rooms on a “per room” basis.

Below is the break down I use to analyze a multi-family deal:

I’m not going to go over cost estimation, appraisal value, after repair value, or LTV value. I have gone over this in previous post. This information is calculated by due diligence, and finding out what repairs the place needs. You also need comparable sales / appraisals for the true value of the complex.

Take note of the cap rate. The cap rate is a tool many investors uses to look at what percent they capture the first year on the deal. Some investors will take cap rates of 6.45% – others want high cap rates, of 20%+.

You can calculate the cap rate by dividing the net operating income by the sales price. So in my case, 14,724 / 215,000 = 0.0685, or 6.85%.

Maximize your cap rate by finding cheap properties that need repairs, and get the repair work done at a good cost. You can also adjsut your cap rate by increasing rent. Just think the higher cap rate, the higher your first year return.

Look at my buying cost column on the bottom left hand side of the deal. Some of those are fixed costs, and some are variable cost. As you might know, fixed cost stay the same, variable cost are based on variables in the deal. Majority of the variable costs you’ll run into are based off your loan amount / purchase price. These are your out-of-pocket expenses, around $9,000-10,000.

On the top right hand column, you see the “Rent Roll”, which is where you will find what each unit is renting for. So each 3 bed, 2 bath apartment is renting for $900 total, or $300 per room. So that’s $3,600 a month gross rent, or $43,200 annual gross monthly rent.

Below that is your expenses, broken down in both annual and monthly expenses. You subtract those from your gross rent, and you have your monthly / annual cash flow.

I like to divide my monthly cash flow by my out-of-pocket expenses, which will give me a break even point in months. So after 7.95 months (lets call it 8), I will break even on my investment. That’s not too shabby…

How about we look at this deal now, on what that “creative” savvy investor did, renting each room for $500..

You will notice some numbers stayed the same (fixed costs), and some changed (variable costs). Your monthly note stays the same. Your taxes stay the same. Your property management fees increase (budget 10% of monthly rent for property management fees – even if you’re managing yourself, you can write it off).

Most importantly, you might notice that he increased his cash flow to $2,955 per month, from an original $1,227 per month – that’s a gain of $1,728 per month, or $20,736 per year!

He broke even on his initial investment in 3 1/2 months with a cap rate of 16.49%.

Obviously, more tenants will result in more stress, more occupancy, and more maintenance.  You will need to adjust your numbers accordingly.

Multi-family investing is a tried and true way to gain passive income from the real estate market. I am a firm believer that having control over your money, and investing right, will lead you further than any stock market, mutual fund, or index fund.

With a little knowledge, and the right real estate agent, you can go far in real estate investing.

Why For Sale By Owner Doesn’t Work & How To Sell Your Home For 42% More!


Many home owners each year take the For Sale By Owner route (commonly called FSBO) in order to save a few percentage points on the sale of their home. Most likely they are thinking that they can do the same job, if not better, than a licensed real estate agent.

Some may be able too. I’ve heard of successful FSBO’s. I’ve also heard of the FSBO horror stories. NAR found that 86% of For Sale By Owner’s convert to a REALTOR within 7 weeks of their house on the market. So on average, a For Sale By Owner seller spends about a month and a half trying to sell their home, and then hires a licensed REALTOR.  9 out of 100 sellers will sell their home “For Sale By Owner”.

Did you catch that? 7 weeks on the market and not selling. This is called “opportunity cost”, which is the cost of any activity measured in terms of the value of the best alternative that is not chosen (that is foregone). It is the sacrifice related to the second best choice available to someone.

Many times a home owner will want to list their home on their own, and wait for buyers. Lets say they list on May 1st, and go 7 weeks on the market with no “bites”. They should still be able to convert to a REALTOR and get a sale before “buying season” (May – August) ends.

But what if the home owner decides to list their home, For Sale By Owner on August 1st? Statistically they would convert to a REALTOR in September, where buyers are far and few. Most buyers are trying to buy during the summer, while the school year is not in session. Buyers are also not looking to move during the holidays..

I have my own theories of why majority of home owners will convert to a REALTOR when trying to sell. Let’s look at the typical transaction on a For Sale By Owner will play out.

Owner/Seller (emotionally attached) –> Buyer’s agent (experienced negotiator) –> Buyer (emotionally detached)

So the owner is dealing directly with a buyers agent, someone who specializes in getting prices reduced on homes for their clients. They do this for a living. They’ve done many, many real estate transactions. NAR statistics say that most home owners go through an average of 3-4 real estate transactions in their lives. To put things in perspective, I’ve been through 13 in the past 10 months. Who do you think has the upper hand on this negoitation?

My point being, is that websites such as Zillow.com or ForSaleByOwner.com is cheating motivated sellers into thinking they will somehow save money on the sale of their home, if they do it themselves. What those sites don’t tell you, is in 2010 REALTORS sold houses at a 42% price increase than For Sale By Owners.

So basically, you’re saving 3% on a sellers commission and risking 42%.

Hiring a REALTOR puts you in a different position, see below:

Owner/Seller (emotionally attached) –> Seller’s agent (experienced negotiator) –> Buyer’s Agent (experienced negotiator) –> Buyer (emotionally detached)

So doesn’t it make sense to hire a REALTOR? Well, yes it does. REALTORs have access to the one thing that For Sale By Owner’s do not – the MLS. The MLS is the multiple listing service, what every real estate agent lists their properties on for other agents and buyers too see. This is the most common method your home will be found, and will be sold.

The problem is that there are a lot of homes on the market. How will yours stand out? I’ve seen FSBO open houses with 1 “Open House” sign. I always wanted to stop in and ask them how it was working out. I’ve found that in my open houses, my response rate is directly proportionate to the amount of “Open House” signs I put out.

The difference is that I’ve got 20+ open house signs in my garage ready to go, with balloons, to market someones house. It’s something I do once a weekend. It’s not something I just decided to do one weekend and see if anyone shows up. It is a practiced, and refined process, which ensures maximum buyers through your door.

There are some FSBO owners who take the sale of their house very serious. This is not a bad thing, by any means. The problem (as stated before) is that home owners are emotionally attached to the house. I’ve seen deals fall apart because the seller was insulted by the buyers agent comments, and did not want to deal with the. You’re going to have to deal with buyer’s agents one way or another, if you sell your home your self.

It’s unbelievable what sellers will do to “control” the deal, and feel like they’ve won something. It’s up to the sellers agent to make sure that the seller feels good about the sale of their house, but also make sure they are not making rash decisions that will jeopardize the sale of their home. Chasing buyers away in this market is a big “no-no”.

This is the reason why For Sale By Owner homes simply do not work, in this market – if you get far enough to get a buyer in the door. Most FSBO sellers believe that putting a sign up that says FOR SALE BY OWNER will sell their house. Contrary to popular belief by FSBO sellers, this might increase offers (if it’s in a high volume area) but it will decrease the size of the offer.

Buyers agents, and buyers “smell blood” when they see that red and white For Sale By Owner sign. Some real estate investors I work with only want to buy FSBO homes, because they know that the person selling the home is not an informed real estate professional, with proper representation.

The bottom line is if you are considering selling your home, you owe it to yourself to speak with a few REALTORs and see what they offer. Most REALTORs offer a no-obligation, in home, consultation

Common Real Estate Questions: Buying a home in the “Perfect Storm”


There are a new type of home buyers on the horizon for years to come – Generation Y, also known as Echo Boomers. This generation is known as the generation with their own identity, who is very familiar with digital technology. Echo Boomers are also known to manage their money very well, unlike other generations before, most likely due to the assistance of technology (online banking, eChecks, ePayments, etc).

I could go into socioeconomics (which I enjoy very much), but my blog is dedicated to real estate and how this relates to real estate.

So there is a LOT of people about to buy their first home. If you’re one of those people, most likely you’re either a GenX or GenY person. I am going to explain the most common questions, and answers, when buying a home – as well as the process involved in purchasing a home in today’s market.

Let me first say that the real estate industry is rapidly changing each year with the incorporation of technology, iPhones, iPads, GPS, and other tools of the business. Other ways the industry has changed in the past 10-20 years in the incorporation of the internet with real estate transactions. I’m sure you’ve already been apart of this, with such sites as REALTOR.com, HOMES.com, ZILLOW.com, TRULIA.com, etc.

It can be overwhelming. I know. I was there once. I completed my first real estate transaction when I was 23 years old. I will say it is a learning process, and I’ve done multiple transactions since then. Sometimes I have to remind myself of that, and how complicated of a transaction transferring real estate can be.

Not to worry – as I am going to first explain the entire process of buying a home in today’s market, and explain why we’re in a “buyers market”.

First, you must understand if it is a good time for you buy right now. This is a question you will have to ask yourself. I can’t give you this answer, but I can offer some suggestions.

Take a look at the Trulia Rent vs. Buy Index for 2011, and see if it is better for you to own than rent – this is all variable based on where you live, as you will see below.

So as you can see, if you live in Houston, it is more beneficial to you to own rather than rent. At the same time, if you lived in New York, it would be more beneficial to you to rent than own. This information is based on the average price to rent, and the average price to buy.

Always keep in mind that if you are renting, you are paying for someone else to own. This is how many people create wealth in real estate. Keep in mind, that when you become a homeowner – you are the “landlord”. There is not a property management company to call to fix repairs, or replace broken items on your house. It is your duty to maintain your home, and there is a cost associated with that.

So why does everyone keep saying its a “buyers market”?

 You must first understand the real estate cycle and interest rates – to understand why its a buyers market.

This is what the real estate cycle looks like. Theory, and years of recorded values, suggest that peak real estate values (good for sellers, bad for buyers = sellers market) is related to excitement, and euphoria. This is considered a high risk, low opportunity time to buy real estate, due to values most likely on the way to decreasing.

Vice versa, the low-end of the cycle presents low risk to buy, with high opportunity. This is associated with times of a depression, recession, fear, and panic. This is a good time to buy, because values are low, and will significantly increase over time.

Now that you understand the real estate market cycle, what part of the cycle do you think we are currently in – for 2011?

We now know that it is cheaper to buy than rent in Houston, that the values are currently low (due to the real estate boom/bust cycle), but what about lending? You’re going to need to finance this home, and get a mortgage – so how about interest rates?

Here is what historical interest rates looks like from 1972 to 2011. You will notice that if you bought a home in the early 1980’s, you could be paying 15-18% interest on your loan. Today, you will pay from 4-5.5% on your house note.

The data suggests that there is currently a “perfect storm” for buyers right now in specific real estate markets. Houston is one of them. This is why investors are flocking to the Houston area to buy up undervalued homes, because the goal is to buy low and sell high – so they buy at the bust, and sell at the boom.

So what are the costs associated with purchasing a home? Here is a break down of what you can expect to purchase a home. Some of these are variable, and can be negotiated with the offer on the home you wish to purchase:

Out of pocket fees:

  • Inspection fee  – $300-400 – This is a must for any first time home owner. You will pay a licensed home inspector to check the entire home out, and they will give you a detailed report of what works, and what doesn’t – before you purchase the home. This is great, because as a buyer, you have the ability to request for repairs to be completed before you buy.
  • Option fee – $100-500 – This is a required deposit that you must put down to have the “option” to walk away from the deal, in the first X number of days of the contract. This is a protection for the buyer – you want this. When the deal closes, this will be credited back towards the sale price of the house.
  • Earnest money deposit – $500-2,000 – Typically this is $1,000, and this will reserve the home for you after the 11th day of the contract. This puts your skin in the game, and lets the seller know you are serious about purchasing their home. When the deal closes, this will be credited back towards the sale price of the house.
  • Down payment – 3-20% of purchase price – Depending on your loan, you will need at least 3% to 20% minimum down payment for the house. If you have a VA loan, you will qualify for no money down. FHA is 3% down. Conventional loans are 20% down.

Fees rolled into your note:

  • Lender fees – $800-2,000 – This is the cost associated with originating your loan, underwriting your loan, and other fees your lender might charge you. Most likely, these will be paid at closing and will not require you to pay them out-of-pocket. They can be financed into your mortgage. Check with a few lenders and find out their rates, and fees – then compare to see who has the best deal.
  • Survey – $400-800 – Your lender will require a survey on the property ou are wanting to purchase. Hopefully the seller will have a survey, and you can use that. If not, the contract has a spot for the seller to provide a new one (and pay for it) – or you have too. This is another fee that will be rolled into your note, and you do not pay out-of-pocket.
  • Title company fees / closing fees – $500-$1,500 – These are fees that the title company will charge you to close on the house. These fees include recording fees, document preparation fees, and other miscellaneous charges that you might incur when closing on a house.

So now you know the fees associated with purchasing a home.

Did you notice that you did not pay a REALTOR commission? That is because buyers do not pay REALTORs’ commissions, only sellers do! This is why it is important to work with a buyers agent – and not the listing agent of the house you want. Your agent must legally have your best interest in mind, during the entire transaction. If you work with the listing agent, whose job it is to sell the house, whose interest do they have before yours? Essentially, it cost you $0 to work with a buyers agent, and it will (if you have a good agent) save you thousands.

So after you have decided you want to buy a house, you know the costs associated with buying a house, you know it’s better for you to own than rent – whats the next step?

You need to get pre-qualified through a loan officer to originate your home loan. The pre-qualification process is fairly simple. The person I use needs to speak with you 10-15 minutes over the phone, and you’re done. He will run the numbers, and find out how much of a home you can afford. They will prepare a “pre-qualification letter”, and email it to you. This letter will give you the dollar amount you can spend on your new home. This process should take less than 30 minutes of your time.

Once you have been pre-qualified, you will need to find a realtor to work with. Most likely you know someone, or you know someone who knows someone. I would recommend going this route. You can also search your local MLS for an agent, such as Houston’s public MLS access is HAR.com. Let your agent know that you have been pre-qualified, and the specifics you are looking for.

Spend time looking at houses, and once you find the one you want, ask your agent to run a CMA (comparative market analysis) on the house want. This will give you data that is very helpful in the offer you want to submit on the house. It will show you active, pending, and sold listings within 60 to 90 days, with comparable houses. That way you’ll know if you’re getting a good deal, or need to negotiate the price down..

After you decide on the price you want to pay, you will submit your offer to the seller. This can include the purchase price of the house, as well as funding needed at closing from the seller to help you out with out-of-pocket expenses.

Negotiations occur, and once all parties have agreed on the price then the contract is signed and executed (all parties sign). Your agent will send you a copy of the contract, and send the contract to your loan officer. Your loan officer will begin the process of underwriting your loan, and might need more information from you.

Things will be happening fast here. Your agent will be working. Your loan officer will be working. The listing agent will be working. They will all need cooperation from you.

You will submit the option fee of $100 to the buyer, and send the earnest money deposit of $1,000 to the title company.

The first 10 days of the day after the contract is executed (depending on how the contract is written, I always do 10 days $100 for option periods) you will be in the option period. This gives you the unrestricted right to terminate the contract and risk losing $100 – for no reason.

During the option period, it is critical that you get your inspections done. If something comes up, and the seller will not agree to fix, you still have the option to back out in the first 10 days. After inspections are complete, you will most likely do some minor negotiations on repairs.

The 11th day of the contract you go into whats considered the earnest money period. If you back out of the deal, you will lose $1,000. It ensures that you will not tie up the sellers house with no “skin in the game”.

From here on out, everything is simple. If you are financing the house, your lending will order an appraisal on the subject home. Keep in mind the house must appraise for the price you agreed upon (or more!), or you will have to renegotiate again on price.

Typically deals close in about 30 days. The closing process is fairly simple, and you should be in and out within an hour. Your loan officer will tell you how much money you will need to bring to closing for your down payment.

After the deal closes and funds, you are now a homeowner! Enjoy the American dream.