Introduction to Residential Real Estate Investments
for the New Investor or the Wannabe Investor
In order to become a residential real estate investor, there are a few terms and scenarios of which they should at least have a working knowledge. Let’s explore some of those before we delve deeper into the how’s of becoming a successful investor. We’ll discuss more about the “how’s” in later posts.
Why are so many people turning to residential real estate investing these days?
There are a growing number of people these days who, for a variety of reasons, no longer want to work for someone else. I believe the number one reason is the fact that true job security is really a thing of the past. There was a time, not too awfully long ago when a person could graduate from high school or college, go to work for a company and stay with that company until they retired. Nowadays, not so much. Companies are merging, selling and going out of business at an often alarming rate. They are closing their local branches and opening new branches in faraway lands or outsourcing. Retailers like Kmart, Sears, and Toy-R-Us are shutting (or have shut down) their stores all over the country.
Even longstanding factories that have survived economic crashes and slow periods have seen massive layoffs and even closures. At the end of 2017, the 112-year-old Cone Denim White Oak Plant in Greensboro, NC shut its doors laying off approximately 208 people in the process. This historical plant manufactured blue jeans and was the last major manufacturer of selvage denim in the US. I’m sure after over a century in operation, most workers never imagined themselves out of a job.
I would be remiss if I didn’t mention the “Ma Bell” monopoly disintegration wherein more than 40,000 people lost their jobs and livelihood in 1982 when the Federal Government forced the company to split their holdings when charges were filed against them under the Sherman Antitrust Act.
As an employee at a traditional workplace, you are always trying to work your way up the corporate ladder into a better position, only oftentimes to find out that your ladder is leaning up against the wrong wall. A raise can lead to more income, but also requires more hours, which is the one commodity we want to have more of in the future.
Most of us are allocated two weeks vacation time a year from our employers. During this time we don’t earn anything extra. Wouldn’t it be nice if you continued to earn income even while away on vacation, attending your child’s sporting event or even while sleeping? This is the beauty of real estate investing and is the main goal and dreams of those who step into this line of work.
The moral to all of this, from a residential real estate investor viewpoint is twofold (1) While the world might find a way to do without a Denim factory, or a Kmart or even a 411 operator…it will never find a way to do without people needing a place to live, and, (2) With a specific goal in mind, lots of patience, hard work and sacrifice, you can be the “master of your own universe”. You can truly earn money without ever leaving your home. Will it happen overnight? No, but it will never happen if you don’t jump off the corporate ladder and follow your dream.
My favorite motivational speaker of all time, Zig Ziglar, once said “You will always get what you want by helping others get what they want.” What does that mean to a real estate investor? The one thing that every person wants is a nice place to live. When I say “nice” that doesn’t necessarily translate to “mansion”. For most of us, it translates to wanting a clean, functional place to call home in a neighborhood that we aren’t ashamed of and at a price we can afford. You give that to people and they will give you money. You’ve helped them get what they want and now they are helping you.
If your goal is to become a successful residential real estate investor, then you must have specific goals. You can’t deal in generalities. To risk redundancy, I’ll once again quote Zig “If you go to work tomorrow because that’s what you did yesterday, you’re not going to be as good tomorrow as you were yesterday because now you’re two days older and no closer to that goal that you did not have. You can’t make it as a wandering generality.”
So what is required to become an investor? What are the qualifications? The answer is short and simple. It takes a lot of patience, hard work and research. How much does it cost? That varies with every community and with every investment scenario. It also varies with the type of investor that you want to become.
Let’s look at three types of Investors:
Frugal Investor: The frugal investor buys low usually choosing to purchase class C or D properties and spends cash on the purchase. The frugal investor spends only what is necessary to make the unit habitable, does most of the work him/herself and holds the properties for the monthly income it produces in rent or sells quickly in order to move onto their next project.
House Hacker: This is a process in which you get other people to pay your mortgage for you. Arguably, the most popular version of the House Hacker is that of an investor who purchases a duplex, triplex or quadplex. They live in one unit while collecting rent on the other unit(s). The rent from the other unit(s) pay any expenses the investor incurs from the property. If the House Hacker was also a Frugal Investor, the money he/she receives from rental income is actual profit once the usual expenses like maintenance, taxes and insurance have been paid.
Another version of the House Hacker is the investor who purchases a house with a guest house or garage apartment in the back. They live in the guest house or garage apartment while renting the larger house out. An even smaller, more common version, is the college student, fixed income person or newly divorced person who rents out spare bedrooms in their home so their renters pay the mortgage for them.
The last version I’ll mention here is what I affectionately call the “Squatter House Hacker”. That’s the investor who buys a Class C or D property for cash and then lives in it while fixing it up. This is not for the casual investor because the sacrifices are sundry and oftentimes extremely inconvenient. Things we take for granted on a daily basis, like flushing toilets, showers, hot water, central heat and air, might not even exist in the beginning. This version requires more patience and sacrifice than most investors are willing to expend. However, if you have the stomach for it, this is a way to grow your portfolio without growing debt and with the least amount of financial exposure. Chances are great that if you find yourself unable to complete your project or need to pull out for other reasons, you should be able to sell it for at least what you have in it at that point.
BRRRR Investor: This is an acronym for “Buy, Renovate, Rent, Refinance, Repeat”. We’ll go into more depth on this type of investor as this type of investing has gained a considerable amount of popularity in the past decade or so.
B – Buy.
This is the foundation upon which all things residential real estate investing hinge. There’s an old and true saying that goes something like “a product or service is only worth whatever someone is willing to pay for it.” Value is very often subjective. If you are purchasing the property as a flip (buy, renovate, sell), then you will know exactly how well you did when you sell the property and at that time can make any necessary adjustments to your business if necessary. However, if you are a “buy and hold” investor (meaning you intend this property to be a rental), then it’s much more difficult, short term, to know if you made the best deal possible on your initial purchase.
The key goal in the BRRRR strategy is to pull all of the money that you have invested in the property out by refinancing it so in effect, you bought a property for nothing yet you are continuing to gain equity as long as you hold onto the property.
When you get ready to refinance remember that most lenders will loan up to 75 percent of the value of the property in a refinancing scenario. If you’re looking to draw out as much money as possible from the value of your property so you can invest in another, this is a good goal. However, if you aren’t looking for faster volume growth, then a 70 percent loan to value ratio might be a better plan. Why? Because while there is only a 5 percent difference between the two numbers, the refinancing costs will be markedly higher at 75 percent. The other major reason is how aiming for 75 percent affected the contingencies. Most people tend to go over budget not under so when aiming for 75 percent, most usually wind up at 80. Aiming at 70 should get you there or at worse case scenario 75.
Cash is always the easiest way to go when getting that first property. However, not everyone has that much cash laying around so, in that case, financing is something with which you should be extremely familiar prior to buying your first property. There are many different types of financing available. Of course, there’s the financial institution with which you have already established a relationship in your personal financial dealings. In addition to that route, there’s seller financing, private loans, hard money loans, etc.
R – Rehab
Unless you are purchasing a turnkey property, this part will require a large amount of thought and research…and work. The main questions you should ask yourself at this stage are (1) What does this property NEED in order to be functional and liveable? and (2) What improvements do I need to make in order to add more value than cost? Notice that in both questions I said “need”? While it’s always a great idea to make the property more attractive than it was when you found it, this is the area that puts investors over their budget quickly. If you’re doing a luxury property, then go ahead and install soapstone or quartz counter tops with exotic hardwoods and top of the line appliances, because in that market, those are expected improvements in order to get top dollar for your property either in sales or rental income.
However, if it’s not a luxury property, skipping the current trends and sticking to the classic finishes will not only provide an attractive property but will also provide a profit down the road. That being said, it’s always a good choice to get rid of peel and stick vinyl tile in exchange for ceramic tile and refinishing existing hardwoods is almost always cheaper than installing new hardwoods especially if you’re willing (and able) to do a majority of the work rather than hiring a contractor to do it for you.
Be ready to skip the areas that aren’t going to give you immediate value. Areas such as bedrooms, dining rooms, garages, laundry rooms and basements really don’t add enough value to justify spending the bulk of your rehab dollars on them. Make sure they’re clean, painted, have good flooring and (in the case of the basement) water proofed and move on.
The most important part of the rehab is making sure that the entire property is functional, safe and healthy. Word spreads like wildfire in the real estate world…..and among renters…so no investor wants to be branded a slumlord. Making a rental (or any property) pretty is a wonderful goal, but the main goal should be to make it a fully functioning, safe and healthy property so don’t skimp on waterproofing the basement, fixing roofs, updating old and potentially dangerous electrical and rusty plumbing. Doing all of this in the short term might take a huge chunk out of the money you allocated for installing that dream kitchen but it will save you untold amounts of money in the long term from having to rip that dream kitchen out because of an electrical fire or because those old pipes leaked water in the walls and you had to pay a professional company to do mold remediation on a vacant property because the tenants had to move out due to the mold.
Oh yeah! Don’t forget about the exterior! I don’t care how pretty you’ve made the interior and how functional, safe and healthy you’ve made the property, if you can’t get the potential buyer or renter to want to stop and come inside….it’s not going to matter. You should also realize that appraisers are people too. You want their first impression of your property to be a good one too!
R – Rent
A lot of lenders, if not most, are somewhat reluctant to refinance a vacant property. So before seeking a refinance, you need to get a tenant into your property. It’s always better to have a good tenant who pays $100 a month (just an example) on time and takes care of your property than a bad tenant who pays $200 a month (again, just an example) every now and then and who trashes your property. Do your due diligence! You have just spent lots of time, hard work and money on your investment – don’t hand over the keys to just anyone.
Once you’ve gotten a signed lease, you can begin shopping for the refinance. An appraiser will need to come to the property. Never do a drive by appraisal as they tend to be lower than one in which the appraiser actually comes inside. Always alert your tenants before the appraiser is due to arrive and make sure any pets are kenneled and the property is neat and clean when the appraiser arrives.
R – Refinance
When searching for lenders to refinance a single property rental, there are a couple of things you need to ask. You will need to know if they are willing to cash out or if they will only pay off the debt and you will need to know what their seasoning period is. A “seasoning period” is how long you will have to own the property before the bank will lend on the appraised value of the property rather than just on the amount of money you have invested in the property. In order for the BRRRR strategy to work, you will need to borrow on the appraised value. There are lenders that will refinance on the appraised value as soon as the property has been rehabbed. These are the best lenders to find.
Finding the right lender for your situation can be somewhat daunting in the beginning. There are investor clubs in most major cities who meet over lunch once a month or so. Those are great networking opportunities for new investors. There are also a couple of great websites that can lead you in the right direction. For approximately $200, you can sign up with ListSource and/or DataQuick and using their search function plug in the area and price range. It will pull up a list of properties that are not owner occupied and the lender associated with those properties. Once you’ve found several banks that have lent money in similar situations as you, the calls can begin. The beauty of this method is the fact that you already know these banks have made loans similar to what you need.
R – Repeat
Once you’ve refinanced your first property, it’s time to take your cash and move on to the next property!
Here at Decas, we specialize in the BRRRR strategy and can guide you through the process.
We already have an extensive history in Buying, Rehabbing, Refinancing, Renting and
Repeating! We can show you how to get the most out of your rehab budget and what makes
properties more attractive to both potential buyers and potential renters in the Birmingham,
Alabama metro area.
The BRRRR method is a fantastic way to grow your residential real estate investment portfolio
and we would love to help you grow your portfolio! Give us a call or reach out to us via our