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?

If you’ve been reading the blog for a while you know I like stats.  I thought I would compile some stats for what 2011 looked like as landlords for us.

New Purchases

• 26 new rental properties
• 22 are single family houses
• 2 are duplexes
• 1 two houses on a lot
• 1 commercial building
• The most affordable purchase was 40,000 and is rented for $800
• The most expensive purchase was 110,000

Property Management Stats

• 16 tenants still remain from 2009 and 2010
• 35 lease ups
• 8 tenants moved out in 2011
• 5 properties are under repairs or for rent (all new purchases)
• Average time to fill a vacancy took 18 days, longest 32 days, shortest 1 day
• No evictions, but two moved out without getting their deposit back
• Average repairs on move-out $700.  Some we paid, some tenants paid, some split, depending on circumstances
• One $100/per month rent decrease to keep a good tenant
• One $50/per month rent increase for a tenant with rent too low

Landlord Goals for 2012

• December 2012 gross rent collected to be $83,334 or more
• Add 20+ new properties
• Buy 1+ apartment or commercial building
• Convert all tenants to pay online ACH, deposit at the bank directly or pay by mail

Summary

We are very satisfied with how 2012 turned out from a landlord perspective.  It is still my business partner and myself that manage all these properties, if 2012 stays on track we are planning to hire an assistant and one of their primary responsibilities will be property management and lease ups.  Most of the work comes from the new lease ups and phone calls of the properties advertised for rent, if we stopped growing our portfolio more aggressively it would be easily manageable by one person at 10-20 hrs per week.

Why We Haven’t Raised the Rents

We have thought a lot about if it is time to start raising the rents and for 2011 we made the decision that when we are adding 20+ properties a year we don’t want to create more work for ourselves by pushing paying tenants out by increasing the rent.  I doubt many would leave, but even if we lose a couple, it is not worth it.  We had one property that took a while to rent, so we ended up way under market.  So we sent her a rental increase notice for 1/1/2012 which she just paid, but I wouldn’t expect to see a lot of rental increase notices from us in 2012 either.

Well, 2011 is now officially finished.  It was a great year for us and we hit almost all of our goals.

The holiday season being so prevalent I have been thinking a lot about what went right in 2011 and what went wrong.  How to make 2012 even a better year and what to focus on.  We have a new set of goals that are pretty similar to what happened in 2011.  As I have been thinking about this, a quote I have heard comes to my mind.

“The average person spends more time planning their vacation then their finances.”

I was meeting with someone who invests money with us and presenting him an opportunity.  I had not seen him a while so the conversation started with him updating me on how his last trip was and continued with him inviting me to join him on his next trip and giving me the details.  Once we finally got to it, he apologized that he had not had a chance to review the opportunity I had emailed him two weeks ago and would not have time to do anything right now.

Just for fun, I reminded him if he spent half as much time thinking about this investment as he did planning his vacation he would be a lot farther ahead.

Now I am not saying I am against vacations, or don’t take them, but if you do proper planning you can take a lot more of them!

Later this week, I will post a recap of 2011 and what we are planning for 2012.  If anyone has some topics they’d like me to post about specifically let me know, I’ve had a tough time coming up with topics.

The summer flew by and things have been progressing.  We just closed on our latest rental.  It is a giant mess inside and outside. This deal was bought from a local wholesaler who found it via a mailer.  The same person owned it since 1984 and has since moved to Nevada and had it rented out.

The owner was in her 80′s and the wholesaler and I negotiated a carry back and it was pretty funny as she had a mortgage calculator in front of her as we discussed the terms.  She was a really tough negotiator.

I think this is the only 2-story rental house we own, because we buy mostly smaller houses and don’t want to limit our market we mostly stick to single story properties. At the end of the day the numbers work and we have some good financing so this should be a good rental.

I have recently been asked to elaborate on my rental property purchase criteria.  You would think I have an elaborate set of guidelines, must haves and must want but it is not that simple. If you have been following this blog for a while you might remember that we started in the house buy-sell business (flipping) and it took a year before we decided we wanted to start keeping some properties. That means we have taken a different approach to the business.

Like the buy-sell business one of the main criteria is EQUITY today!  For rentals we are looking to pay 75% of ARV value less repairs for any purchase.   So if the property will be worth $100,000 once it is fixed up and requires $10,000 in repairs the most we would pay is $65,000 ($100,000 * 75% = $75,000 – $10,000 in repairs).

The second requirement is CASH-FLOW.  The property must generate a positive cash-flow after all expenses and factoring in 10% on the entire purchase and rehab.  We cannot get traditional financing any more, so we are paying private and hard money rates.  This pretty much means that the max investment on a deal is going to be about 120,000 or so, or else it will not achieve positive cash flow.

So the goal is to buy a property at a discount, collect the cash-flow, leverage some of the investment out and sell or trade when the right substitute investment comes along.  I am hoping to see some appreciation in California at some point, but with our model it really doesn’t matter if it happens or not.  We could sell everything rental we own for a profit in today’s market.

Our criteria is pretty flexible if it can meet the above two goals.  For example many investors don’t like to buy 2 bedroom, 1 bathroom houses, I have no problem with these as long as I can get them for 75% or less of what other 2 bedroom, 1 bathrooms are selling for.

There are some items that are deal breakers:

• If I am afraid to get out of my car in the neighborhood, day or night, I don’t want it.
• If it is over a 45 minute drive from my office, that is probably too far.
• Dirt Roads.

Things I don’t like and would want to pay less:

• Flat or gravel roofs.
• No garage.
• Really busy streets or other major location problems.
• A really old house (1940 or less)

I know I probably didn’t provide anything revolutionary or an exact criteria to follow: instant equity + positive cash-flow + good location is really the formula…

Recently a new member of Bigger Pockets posed a good question.  Why keep any properties long-term if you can make 30-40% ROI reselling a property.

I had an answer in my head, but being the number crunching type of guy I am I wanted to see what the actual numbers would look like.

Here is a spreadsheet I made to answer the question.  I made some assumptions:

• I assumed we are using all-cash
• I assumed the properties will be self managed rentals and expenses are 40%.  I think this is high, but Bigger Pocket members love the 50% rule (less 10% for management)
• I assumed 2% of the purchase price for acquisition cost
• I assumed 8% of sales price for selling costs
• I assumed after 3 years the landlord will sell the property
• I assumed that ARV would remain the same after 3 years
• State and federal tax rate on short-term capital gains is assumed at 40%
• Long-term capital gains tax is assumed at 15$

I ran three properties I decided to keep as rentals.  Property A was an average deal, Property B and C are both pretty good deals (as far as discount achieved).

If you can get to 10 free and clear rentals you would be pulling in roughly $55,000/year after taxes for managing those 10 properties and you could stop looking.  You would have to flip 3-4 properties a year (EVERY YEAR) to achieve about the same after tax profits.

I still buy-sell 15-25 houses a year because I need to generate additional investment capital.  But I think investors are making a big mistake if they completely overlook purchasing rentals when prices are at these levels. If I included the 2006 value of Property A, B, C and did another run with that being the disposition price the landlord would make even more.

I am probably on 20 different local real estate wholesalers email list and it seems like the same thing happens over and over again.

Wholesaler A sends an email blast with a property that is advertised as the next greatest deal.  Usually it is beside train tracks and on a busy street and compared to non-location problems.  Fifteen minutes later wholesalers B-F send me a similar email with the same property 5-10k added to the price and a new logo on the top of their email.

That business model sucks!  To be honest I don’t even bother to open most of the emails I get from these people anymore.

Here is how I would do things if I was a full-time wholesaler.

1. Find 2 to 3 large buyers in a hot investment area within 30 minutes from where I live/work.  I will give some ideas on how I would do this at the end of the post.
2. Ask them about their favorite areas,  items that area deal breakers and any other feedback they have.
3. Now it is time to pursue that exact type of product: MLS, mailers, other wholesalers.
4. Every time you get a deal call them directly.  If they say no, ask them what they didn’t like about the property and what numbers the deal would work at for them.  Remember it is important to not be too greedy, if you can find deals that the investor can make money at they will be back again and again.

I think sometimes new wholesalers forget that the investor needs to make a profit if they are going to stay in business.  The guys I know that are most successful at it, almost never have to make more than three phone calls to unload a deal.  They know exactly what every buyer on their list is looking for.

Now if I needed to find a list of buyers there are three things that are pretty easy to do:

1. If you have MLS access, which you should if you are serious about real estate.  Do an MLS search in cities you are thinking of targeting for Closed Sales that had Financing Type: Cash over the last 3 minutes.  Sort it by price and check who took title on each one.  If you see common names those are probably active investors in the area.  Find their phone number (it’s not hard) or mail them if you can’t.
2. Trustee sale buyers have loads of cash and are always hungry for deals.  Hang out and approach the players after.
3. Go to your local Real Estate club and do some old fashioned networking.

So to sum it up: rather than passing Cinderella’s slipper around to many possible princesses why not find your princess up front measure her feet and go find her the perfect slipper?

I was going through some year to date profit and loss numbers on my portfolio of long-term properties.  I do this every couple of months, it really helps me to know the numbers so I can see if there is anything I need to tighten up and what I should buy more of.

After looking at the numbers on some of my duplexes I was really surprised to see how similar the combined P&L was to most of my single family properties.

The numbers look pretty close, don’t they?    The problem is: I paid less for the house; I only have to manage one tenant with the house; and in the last cycle they appreciated at pretty much the same pace.

I know I only provided one example, but I have probably analyzed 30-40 duplex in areas I buy and I can almost always achieve a better cap rate with a single family house.

I have no problem buying and managing duplexes, but sometimes investors internally count them as two houses.  The numbers are almost never as good as two houses.

What I dislike about duplexes

• Duplexes have shared walls (tenants fight)
• Turnover is Higher
• Duplexes seem to be harder to buy at discounts (distress situations allow for discounts)
• You typically pay for water/trash at for multi-family properties
• Smaller Number of Available Properties

What I like about duplexes

• You have two incomes
• Maintenance is less (one roof, one lawn, etc)
• Less competition, many buyers would not even consider a duplex

Disclaimer: I do not own a lot of duplexes or any fourplexes and I do not specialize in managing them.