A friend of mine just email me the attached graph.

To complete a lenders foreclosure process the bank must go to an all cash auction at the court house.  The opening bid is typically simply the loans outstanding balance, but since 2008 the banks have been “dropping” their opening bid to sell the asset directly to an investor.

Purchasing homes at trustee sales come with a lot of risk:

• You buy the property with no warranty
• You are responsible to get the occupant out of the house
• You are responsible for back taxes and possibly other liens

According to the chart in April buyers paid 92% of retail value at the trustee sale.  On top of paying 92% the buyer has to catch up taxes, remove the occupant (usually by paying cash-for-keys) and repair the property. Paying 92% essentially means the buyer will have a total cost over market value.

Clearly these are landlords… but how long can this last?

I’ll be honest I stole this title from another blog post (relating to a different industry), but I think it is very applicable to real estate investing.  Another quote I often think of is: “When is the best time to start? Five years ago, but that’s too late, so why not now.”

Most of people I respect most in this business are not people I would consider to have far superior intelligence compared to the average person.  They have just found a way to consistently set goals, pass the obstacles in front of them and start accomplishing tasks one simple step at a time. Before long they got miles ahead of everyone else.

Sit down and make a list of all the things holding you back from getting started and an associated action to accomplish them and before you know it you will be moving forward.

Back in early 2010 I wrote about my favorite spot to find prospective tenants.  Can you tell I am not very creative in finding them?

I am still renting 80% of my properties via the For Rent sign in the front yard.

But the important question is, once you an application or applications how do you decide if you should rent to the tenant or not?

We are flexible with most aspects, but here are the most important factors:

1. Income Qualifications

If monthly rent is $1,200 and the tenant only makes $2,000 per month, the process is over.  They are never going to be able to pay.  Their credit score or the rest of the story doesn’t really matter.  As a general rule of thumb, we hope for 3x rent (which would be $3,600) but will settle for 2.5x.  I do take into account all income for this calculation.

2. Criminal Background / Eviction Check

I always prepare a criminal check and eviction check (the criminal charge is called an unlawful detainer).  San Bernardino County, where most of my rentals are in, offer this search for free.    Evictions, hard drugs and theft usually will completely eliminate the tenant.  If we see domestic disputes and other crimes this is a red-flag and we usually discuss them with the tenant.

3. Security Deposit

Our typical deposit is $100 above rent.  Again, if rent is $1,200 our requested deposit would be $1,300.  Very rarely are we flexible on the deposit.

 Other Factors to Consider

• Length of Previous Residency: we are looking for tenants to stay at our house for a long time, if they move every year that is a red-flag
• Rental History: we are looking tenants that have experience renting/owning a house before versus apartment
• Length of Employment: the longer the better
• Ready to Move in Quickly: a tenant that is willing to move-in within two weeks is a definite positive
• Pets: we prefer no pets, we do take them and charge a bigger deposit
• Previous Rent Amount: if a tenant is currently paying $800 and applying for $1,200 that is a concern we usually discuss
• Number of Occupants: many of our houses have quite a few occupants, our max is 2 per bedroom, but we like fewer

As you may have noticed a high credit score is not on this list.  We rarely check credit… typically only when something else on the application seems fishy.  Most of our tenants have credit scores in the 500′s anyways, how does knowing that help us?

What we do if we see Red Flags

Many tenants meet criteria 1 through 3 but the one or multiple other factors bring up some red flags.  We will still extend an offer to rent to the tenant but we will ask for an increased deposit.  By California Law you can collect a maximum of 2x rent for a security deposit.  This has worked out with great success for us, if the tenant is unsure about their ability to pay the rent they probably won’t be willing to hand over additional funds.

The stock market is at four year record levels, manufacturing is coming back and we are seeing a lot of positive press on real estate.  Real Estate has caught negative press for over 5 years now, it seems hard to believe that we are that far along but 2007, 2008, 2009, 2010, and 2011 have all passed.

Warren Buffet recently said, “If I had a way of buying a couple hundred thousand single-family homes I would load up on them.”  Every day we learn of a new hedge fund that has plans to buy 100 million plus in single family housing.  From a guy on the ground floor, like me, I have really noticed there really isn’t much inventory out there and everything that does make sense is being chased by tons of bidders.

All this news doesn’t mean the banks aren’t sitting on a ton defaulted loans, but we’ve been talking about that since 2008.  I guess the real question is, how in control of the inventory are the banks/government?  Have they limited the supply to heavily?  Will they over correct and bring on too much inventory?

I have heard the average landlords last two years, I wonder how many people that seize the opportunity the news is talking about can handle being a landlord? I have more questions then answers, on the next couple of years, but I can say I am glad we started loading up on rentals in 2009.

Do you think 2012 will be the year that real estate starts going up again?  Give me your opinion in the comments!

Big checks, quick sales and glamorous before and after photos is something everyone can get excited about.  People who aren’t in the business have tons of questions for me about this process and everyone is ready to do it themselves one day soon!

On the other hand, when I tell them I have rental houses, they usually tell me how they couldn’t handle a midnight phone call to fix a toilet (I still haven’t gone out to one of those).

Fortunately or unfortunately I live in both worlds and really like the multi-pronged approach.  The buy-sell business generates big chunks of capital and requires a lot of continuous effort.  The landlord side is an investment in the future, it does generate some short-term capital (cash-flow) but its primary purpose is future value (amortization and appreciation).

Running the two businesses together gives you the following synergies:

1. Deal Flow
   Some make sense to resell, some make sense to rent and some make sense for both.  If you are already looking at a lot of deals you might be passing on stuff you should be keeping.
2. Consistent Income
   The buy-sell business income is very lumpy.  Landlording can bring in some cash-flow during your slow months to keep the ship rolling.
3. Tax Advantages
   Flipping doesn’t really give you any tax benefits.  Buying rentals gives you depreciation, passive gains and a lot of good stuff.  Build this side of your income (that is why the rich pay so little tax).
4. Pulse on the Market
   The market is ever changing.  The more active you are in it, the more you get a feel for what is going on.  Are buyers getting aggressive?  Are renters getting aggressive?  Is a ton of inventory starting to come out?  This is stuff you need to know!
5. Gives you Focus
   I have clear goals and most of them are on the landlording side of the business.  A lot of capital is required to make these happen and most of that is going to come from the buy-sell side.  I know what I need to do to hit my goals and that is what keeps me excited to go to work every day.

Words of Caution

Don’t start buying rentals until you’re ready.  Over our first 15 deals we didn’t even talk about doing any rental properties, we needed to build up a “war chest” of cash for our business cash-flow before we could consider diverting profits to rentals.  Things always go wrong and they’re expensive to fix.

Once you get in the rental game: buy rentals with equity from day 1.  Flippers are trained to analyze a deal that can make a profit, I advocate for that same criteria to be added to the buy-and-hold model.  Just because a property can cash-flow doesn’t mean you should pay market value.

And lastly, don’t build a portfolio of failed flips.  Every so often a couple die-hard buy-sell guys tell me of a rental they kept that doesn’t really make sense.  After some digging I realize their intention was to sell it for a profit but it didn’t work out.  Rather than losing 5,000 or 10,000 they decide to keep it and usually have too much $$$ tied up in it or a big negative cash-flow every month.  Just sell it, lose money and move on.

We’ve all heard stories of houses you can buy for $5,000.  They usually are in Michigan or Ohio.  In June of 2011 we got a good introduction from a friend and fellow investor and were able to buy a house for $5,000 in Southern California.

In 2006 a family that build houses bought three parcels of land next to each other with the intention of building new houses on it.  They got a hard money loan and ended up building houses on both sides of an existing house built in the early 1900′s.  In hindsight, 2006 was not the best time to build a house in Southern California and the lender ended up with a borrower who had no equity and wasn’t buying.

When we originally talked to the note holder, the lender wanted about 20,000 for the note on the house, it had ~12,000 in back taxes and the City involved had put a lien on the property and was threatening to demolish it.  We decided to pass as it was too much of a head ache for the potential.

Three months later I followed up and sure enough it was still available.  Things had gotten worse, the City was threatening to demolish the house and lien the parcel.  As the title alludes to, the Seller now had the right motivation and we came to a meeting of he minds at 5,000.  The lender was owed over 200,000, was from Orange County and just wanted to be rid of this investment.  The good news was, before we inked the paperwork, I was able to convince the owner of the property to sign a deed in lieu of foreclosure (at no cost) and negotiate the City violation down to a very manageable amount and get an extension on the violations so the repairs could be made to the house.

My partner and I discussed our potential exit strategies and we decided that if we could sell it for a certain number we would prefer not to rehab a house of this age.  We ended up listing it in the MLS, with a pretty specific description:

CASH ONLY. CASH ONLY. CASH ONLY. Seller purchased note and has possession now. Major repairs needed. Electric meter is gone, City wants property fixed. All cash, big deposit and quick closing is what motivates Seller.

Two days and 10 offers later we put it in escrow above list price.  The buyer wasn’t the highest offer but offered a good number and we felt very comfortable with the fact that they would close.

My favorite part was it took almost no cash out of pocket (just the 5,000).  The back taxes and City lien fees were paid out of our sales escrow.

I just want to encourage people that with hard work and a little creativity you can make deals happen with very little money.  Deals like this don’t happen every day but they are definitely possible.

Often times people ask me if my typical offer is a certain percentage of list price.  The answer is it depends.

House #27 taught me a lesson I will never forget.  It was listed at $63,000 and in superb condition (more or less ready to be rented).  After looking at it, I told my partner I thought it was a waste of time to make an offer as an owner occupant would pay a lot more.  I called the listing agent to see if he would represent us and he basically said for a $500 commission it was a waste of his time.  We sent in our own offer just above list price and three days later a highest and best request came.  We normally don’t go up much, but we decided to offer just over 73,000.  Two days later he called and said the bank had accepted our offer.  I asked him some questions and he said, you guys were the highest offer by over 10,000.  I was thinking “oh crap, what did we miss?.”  Apparently, we didn’t miss anything, it appraised as-is for 130,000 and we got a private loan for more then our total cost.  Two years later it is still a great rental.  There is nothing wrong with getting paid to buy a positive cash-flow rental.

House #79 is another example of not being worried about the list price.  This house was a total mess.  The bank originally had it listed at 185,000.  We sent in an offer at 110,000.  The bank lowered the price to 165,000.  We sent in an offer at 110,000.  The agent started asking us questions (proof we had seen the property, proof that we were capable to make the repairs) and after figuring out all the issues we ended up agreeing to buy the property at 100,000.  That is 60% of list price.

As you know your market, you will know the number that will work and not be as concerned about list price.

According to the SBA, over 50% of small businesses fail in the first five years.  I would venture to say that real estate investing is a lot tougher and even more fail.  There are so many moving pieces but managing the cash flow is the silent killer.

Here is how the process works for us:

• You write one big check to buy the house
  You can use private or hard money loans to leverage your money.  It is expensive but a life saver.   In this market even the most aggressive lenders require us to have 20% of the total cost into the deal.
• You write many little checks to fix the house
  Your contractors get paid upfront no matter what.
• You wait 1 to 3 months for offers and escrow to close
  During this time you will have loan payments, property tax bills, utility bills, potential break-ins and vandalism.
• You sell the house and hope to get an even bigger check back
  This is the most discouraging process for us.  Very little of it is in your control.  Lenders will come up with ridiculous requirements and ridiculous timeframes.    They will waste 45 days and deny the borrower.  They will ask for whatever they want and you will give it to them because they call the shots.

As arduous as the process seems, it is workable and relatively easy to manage when you have one or two houses in the cycle at a time.  But as your business grows you will need to have more and more active deals in the pipeline at once.

Here are some tips that have helped us as we have scaled relatively quickly.

• Be selective on what buyer you put into escrow
  Early on I made this mistake multiple times.  I would put the absolute highest offer in escrow if I saw a lender approval letter.  Not all offers are created equal.  Don’t waste your time with marginal buyers.
• Stay on budget!
  Once you spend extra money it is gone forever.   Just because a deal has a good margin doesn’t give you the right to be flexible on the budget.
• Don’t do mediocre deals
  If you have your money and time tied up in mediocre deals you might have to pass on some awesome ones!  Don’t waste your time with them.
• Pick Aggressive Buyer’s Agent
  In 2010 especially we had many scenarios where we had multiple offers.  I would pick my top 3 or 4 offers and try to get their highest and best.  But secretly I always leaned towards the agents that will call me every day or three times a day to see how they can get their client in the house.  If they are willing to bug me that much, imagine what they will do when the lender needs something.
• Never count on the money until it is in your bank account

In 2011 we had two deals fall out of escrow after they received loan docs.   The money isn’t made until it is in your bank account.

• Find other streams of income to level out the peaks and valleys
  We have slowly been investing our profits into rentals.  Those checks come in every month and help us survive the valleys.  Wholesaling is another good way to even things out.
• Always keep reserve cash on hand
  Last and probably the most important is, you need to have solid reserves or access to money.  Stuff happens and when you own real estate it usually costs a lot of money to fix.

I try to buy a lot of houses and every so often I think I am pretty close and am disappointed to hear the dreaded No from a seller.  Sometimes they are less polite and use words like: “cheap”, “crazy”, “wasting my time”, etc.

Here are some of the things I remind myself when I hear no:

This is a Numbers Game

You are not going to buy every house you offer on.  But if you stay in the game long enough and make enough offers you will eventually get to a Yes.

There is Lots of Inventory

The market is big.  There are a lot of distressed sellers right now.  Don’t worry about the deals you miss, focus on the things you can control.

No can be Temporary

The percentage of escrows that don’t make it to the finish line is substantial.  If the Seller picks another offer don’t give up on the property.

Investors are Required

Owner occupants cannot buy most of the stuff I go after.  My job of revitalizing a neighborhood is required and should be profitable.

Be Relentless

Persistence pays.  Keep at it.  You will hit slumps, but you can only get out of them if you don’t give up.

The process of buying should be a math equation.  If you normally get 20% of what you offer on and you need to buy 5 properties a month you need to make at least 25 offers on properties in a given month.

I have posted a lot about wholesaling and how I think it should be done on this blog.  Many beginners seem attracted to it because it requires the least amount of capital and has very few moving parts.  In reality I think this is one of the hardest things a real estate investor can do.  You have to compete with people like me and buy the house cheaper than I can, so you can sell it to me and make a profit.  It is possible, but I have most of the benefits namely more money and more experience.

Now let me tell you a story about the niche Mary has found (I changed her name as I didn’t tell her I was writing this), she is a real estate agent and small investor.  One day I put one of my rentals in the MLS for real estate agents to help me rent it.  Not very many people do this, but I figured I would give it a shot.

A week later Mary called me and said she had a tenant she would like to show the property.  She showed it, the tenant wanted it and we scheduled a three way meeting.  All the paperwork got signed and we had three happy parties: the tenant loved the house; I was satisfied Mary delivered the tenant to me on a silver platter (they saw the property and liked it, they filled out an application, and they had a credit check and had proof of income); and Mary got paid.  We have a deal where I pay her between 2.5% and 3% of a one year lease, which is really a bargain (3% of $1,000/month is 12,000 x .03 = $360).

I stopped listing my properties in the MLS, but I still give Mary a list of all my properties and she has helped me rent five or six.  After about the third one I figured out what she does.  She takes my list and makes two or three signed and posts them near my house (not right beside my sign, but close enough).  She then meets the tenants she feels are qualified and does all the paperwork and emails it to me.  If I like them we do a meeting and sign paperwork.

Her model is great because there is not very much competition.  The start-up costs are minimal (just some signs) and the market is huge.   She also gets to make connections with many landlords and learn firsthand what tenants like and don’t like about every property.  The work can also easily be done “after hours” if you have a full-time job.

I think someone could easily generate $1,500 to $3,000/month doing this part-time and learning so much along the way.  You could very easily always have 20 to 30 signs up and just keep a list of tenants and properties rolling.  I know it’s not the most glamorous work but I think the odds of success are astronomically higher then wholesaling.

What do you think?