Archive for May, 2008
Comments Off on Something to Depreciate
Seasoned real estate investors know there are many advantages to owning income property; benefits like cash flow, principal pay down, and the tax deductions for loan interest and depreciation.
Most new investors are familiar with all of those terms except depreciation. So, what is it? Well, it’s an accounting term that basically says assets wear out or get used up over a period of time. Depreciation is a way to spread the purchase cost of something over the number of years it’s expected to last before it finally wears out.
Understandably, different kinds of things have different lifespans. A refrigerator, for example, has a shorter lifespan than oh, say, a garage. Therefore, it has a faster depreciation schedule. Land, on the other hand, never gets used up. I hate to be the bearer of bad news, but even if greenhouse gas gets the best of us, the land will still be here. We won’t.
Somewhere along the line, Congress, and the accountants, businesses, and I suppose, even the I.R.S. got together and decided that if you’re going to invest in America — through real estate, or a business, you should get a break on your taxes. Collectively, they came up with something called a depreciation schedule for four different categories. The categories are:
- Land – which, of course, never gets used up. No tax break here.
- Personal Property – in a rental, this would be things like the appliances. Personal property has a 5 year depreciation schedule.
- Building – For residential property, 27.5 years, for other types of property it’s 39 years.
- Land improvements – includes landscaping, driveways, the garage, the water line. This is spread over 15 years.
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Comments Off on One, Two, Three or Four Units: What’s the Right Fit?
This morning a friend asked my opinion of buying single family homes as rental properties. Believe it or not, I think it can be a great idea.
A lot of people don’t understand that investing in rental real estate can be tailored to your goals, risk tolerance and lifestyle.
There are several advantages of owning rental homes. First, leases for these properties typically require the tenant to pay all the utility bills, mow the lawn, and shovel the walk. The owner, or landlord, has fewer ongoing responsibilities. What’s more, in the event you want to sell the property and move on, there is a large pool of potential buyers in the marketplace. Some people believe this makes owning single family home rentals a more flexible investment.
The most significant disadvantage of single family home rentals is that when the house is vacant, your vacancy rate is 100%. If you can turn (repaint, recarpet, clean) the home quickly, this may not be an issue. However, if there is damage that requires more extensive repair, you may be vacant for some time; which will, of course, require you to dig into your own pocket to pay the bills.
One of the challenges I’ve personally found is if prospective tenants have children, they generally aren’t willing to move in after Labor Day. It’s, an important consideration if the home is family-friendly.
As with any property, it is absolutely essential to do an income property analysis before you write an offer. That is too complicated an excercise to try to explain here, but feel free to give me a call. I’d be happy to help.
Comments Off on Good News in Twin Cities House and Duplex Sales (Believe It or Not)
The Minneapolis Area Association of Realtors (MAAR) released its weekly market activity report yesterday. And, incredibly, there was some good news.
Seven hundred and fourteen (714) purchase agreements were signed the week ending May 17. This figure is 1.7 percent above the number of pending sales during the same period last year.
This is only the first time in the last ten months, and just the second time in the last two years that this has happened.
Of course, there’s always a “but” these days. Of those transactions, 27.5 percent were foreclosures or short sales. And, over the last three months, the total number of pending sales is down 10.3 percent from 2007.
New listings have also dropped 13.9 percent for the same time frame. In fact, there are 700 fewer homes for sale right now than there were at this time last year. This number should increase as more and more sellers wait to put their homes on the market.
Which leads us back to that darned high school economics class: as supply decreases, eventually, prices should go up.
Unfortunately, MAAR doesn’t split multi-family properties out as a separate statistic. However, I can tell you that using my rather mediocre statistical abilities, during the week ending May 17, 38 duplexes went from Active to Pending status. During the same time last year, only 15 properties were pended. That’s a 253.33% increase over last year. Of those properties, a staggering 78.9% were either bank owned or short sales.
Stunned? Yeah, me too. I thought things were picking up. Nice to know I’m not hallucinating…this time anyway.
Comments Off on Stay Off the Expired List!
OK, no. I don’t mean those pages in the back of the newspaper with all the obituaries. I mean the MLS’ expired list.
One of the biggest mistakes I see most residential Realtors make when pricing a duplex is measuring all of the finished spaces in both units, adding it up, then multiplying it by the average price per square foot other properties in the area have sold for.
In fact, I saw a case like this recently. Great duplex, tons of updates, terrific location. The tax value of the place is right around $600,000. The agent put it on the market for over $1,000,000. Yes, it’s a big place. And it’s apparent to me that the agent multiplied the finished square feel by the average cost per foot, then maybe added a bump for location.
Finished square feet have nothing to do with pricing a duplex. Well, almost nothing.
As I’ve explained before, the amount of rent has more to do with pricing a duplex than anything else. Of course, location matters too. But, if you have two identical duplexes next to one another on the market, the one with the highest annual rent will be more expensive.
Of course, it is conceivable that having more space in the rental unit would generate more rent. That would be reflected in the revenue. And, if the property is appealing to an owner occupant, the size of the living space will play a part. However, if the rent from the other half is small in comparison to others on the market, it won’t be as affordable as the competition.
Properties that linger on the MLS forever (often due to pricing) cause buyers to wonder what’s wrong with the place. And they begin to ignore it when they search. In fact, every now and then, Realtors do it too.
Price your property correctly the first time, and it will sell.
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Since it’s Memorial Day, a time when we remember people we’ve loved and lost, I thought it would be nice to write about Irene and her Rule of Real Estate. Have you heard of her? My clients have. And she’s earned them more money than Carleton Sheets ever has.
Irene was my grandmother. Irene Balle. She would want you to know that.
My grandparents were part of America’s Greatest Generation. They grew up on western Minnesota farms, survived the Great Depression, relocated to San Francisco during World War II to build ships for the Navy, then returned to Minnesota where they bought their first (and only) home.
Thankfully, there’s some longevity in my family. As a result, I had the great privilege of getting to know them as an adult. I marvelled at them, really. They stayed in their home well into their 90’s; even surviving the tornado that swept through St Peter, Minn., in 1998.
I came home and visited them the summer after the tornado. Most of their windows had been blown out in the storm, scattering shards of glass everywhere; even embedding it in the carpet. When I stopped in, the old carpet had been removed. And for the first time, I got to see the absolutely pristine oak hardwood floors that lied beneath.
Grandma was agonizing over carpet choices. I was incredulous, and said, “Grandma, these floors are beautiful! Don’t cover them with carpet!”
Irene gasped and put her hand to her mouth. “But we wouldn’t want people to think we were poor!”, she exclaimed.
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Comments Off on Next to the Apples and Oranges
OK, since I mentioned it yesterday, I suppose I should explain what the cap rate is. More formally called the capitalization rate, like the gross rent multiplier, it is used as a tool to compare one property to another.
The cap rate is a ratio between the cash flow produced by a property and its original purchase cost. To find the number, you must first subtract all of the expenses from the amount of rent a property generated in a year. Do not factor in the mortgage payments. The remaining balance is called the net operating income or NOI. You then divide this amount by the original purchase price of the building. More simply stated: annual cash flow/cost.
For example, let’s say you paid $200,000 for a duplex. Every year, it takes in $24,000 in rent (we’ll pretend it was occupied 100% of the time). You had, oh, say $7500 in the total annual water bill, insurance, repairs, rand real estate tax and advertising. $24,000 – $7500 = $16,500 as your net operating income. You would then divide $16,500, by the total purchase cost of $200,000, giving you a cap rate of 8.25.
A cap rate can be used as a way to determine how fast an investment will pay for itself. If the cap rate is 10, then 10 percent of the purchase price will be paid back every year, with the total paid off in 10 years. Or, you can also think of a cap rate as the rate of cash return on the property if it were entirely paid off.
The rule of thumb here is the higher a cap rate, the bigger the return on the investment. Be forewarned, however, most properties with high cap rates usually have a higher degree of risk. They are often found in neighborhoods with greater management demands, or, in a property with a great deal of vacancies.
Cap rates for duplexes and small multi-family properties are usually very low. The cap rate is a much more accurate measure when applied to larger, commercial properties.
Comments Off on Fruit As Self Defense
I read a Reurters article the other day about a gentleman in California who since the year 2000, purchased nine single family homes. All of them are now being foreclosed upon. The article blamed negative amortization loans for his demise. What the article doesn’t say is just exactly what this man’s investment strategy had been. Had he intended to simply ride the appreciation? Was he renting the homes out?
I’ve had my California real estate license. And I know, at least in the Los Angeles area, that investors use a little tool called the gross rent multiplier or GRM. In fact, it is so prevalent that it’s even calculated and displayed on the MLS.
What’s a GRM? Well, like its big sister the cap rate, it’s a way I use to quickly look at an investment property and decide whether or not it makes financial sense compared to the others on the market. Call it a quick and easy way of comparing apples and oranges.
To determine the GRM, simply take the purchase price of the property and divide it by the amount of rent it generates annually. So, if a property is listed for sale at $200,000, and it takes in $2000 a month in rent, or $24,000 a year, its GRM would be 8.33 (200,000/24,000= 8.33). Conversely, if it only generated $18,000 in rent a year, the GRM would be 11.11 (200,000/18,000 = 11.11)
A general rule of thumb is the lower the GRM, the greater the cash flow.
I’ve done too many of these to count. And after endless late nights doing entire spreadsheets on properties, I realized that in the Twin Cities market, anything that’s got a GRM higher than a 10 isn’t going to cash flow. There are exceptions, yes. But we’ll cover those some other time (hint: owner occupied & tax write offs).
If the property meets my criteria, I will stop and do an investment worksheet. I’ll consider all the costs involved in ownership, as well as the market’s current vacancy rate. If I see a negative cash flow, I don’t necessarily discard the property. I just know it’s probably overpriced, and deserves a lower offer.
In the boom years, I warned buyers they wouldn’t hear from me very often. Properties that paid their own way were few and far between. Most of my clients stayed on the sideline. None of those who bought, however, are in predicaments like the California gentleman. Why?
Nobody can predict how much appreciation any real estate market will experience in a coming year. Any agent who tells you otherwise is either the world’s best psychic (and should be sharing lottery numbers) or full of it.
At one point, the market in southern California was experiencing appreciation of as much as 20% a quarter. People bought simply on the hope the value would skyrocket. But they never stopped to do the math. The properties may well have had negative cash flows from the start, meaning the owner had to go into his own pocket to make up the difference. This guy may have been doomed from the moment he started.
Remember, when a property manages to pay for itself from the first day of ownership, it’s a great investment. Any amount it goes up in value is a bonus, not a guarantee.
Comments Off on How To Get A Great Deal
A recent scan of the pending and closed duplex transactions in the Twin Cities since the start of the year stunned me. Now, nothing scientific here, just some observations.
I haven’t done the math, but the majority of the pending small multi-family sales right now have an average number of days on market (DOM) in the double digits. Less than 100 days. Less than three months! Granted, there’s no way to know which of these were cancelled and re-listed at a lower price, but nonetheless, it’s encouraging.
In the last month, several unique duplexes have come on the market in the “waterhoods”; those by the lakes or along the river. They’ve been listed at pretty big prices, and their status has changed to pending in just a month.
I intended to get over to see a unique foreclosure duplex on the bluff in the Cherokee neighborhood of St Paul. It had a beautiful banister, a widow’s walk, and was built years before most of the properties I get to see. At $409,000, I was sure I had plenty of time to get there. Wrong! Market time of a month. Another, a gorgeous home in the Kenwood area which had been converted to a fourplex lasted just 44 days. At a price of $674,000 no less.
As I dug through the records of the properties that have sold and closed already this year, I noticed something interesting about the foreclosures. To illustrate, let me give you an example. There was a unique Queen Anne duplex in the Wedge neighborhood that lingered on the market all winter. When the bank first listed it in September, they did so at a price of $339,000. When that listing expired, they relisted it at $259,000.
Now, a lot of people watch these foreclosures, waiting for the bank to reduce the price to ridiculous. I noted several properties where this had happened, and learned that almost without exception, they ended up selling for well above their asking price. I guess the bank’s agent had the forethought to put the property on the MLS at a price so low it could do nothing but start a bidding war. In those cases, the properties sold at prices $50,000 – $70,000 above list.
In the case of the Queen Anne, however, a buyer wrote and had an offer accepted at $183,000, which is nearly half what the property originally came on the market for. That buyer got a deal because he or she had the courage to write an offer while others lingered, stalking the property until it couldn’t help but sell in a bidding war.
Lessons? If it’s a unique property in good shape and a great location, write the offer today. Even in this market, it might not be there tomorrow. And, as I’ve said before, the only person who “gets a deal” is the one who wrote the offer.
Comments Off on The Up Side Of A Down Market
At the start of the decade, vacancy rates for rental units in the Twin Cities hovered near an almost incomprehensible two percent. Demand for places to rent came probably about as close at it could statistically to 100 percent.
As a result, landlords didn’t have to offer very much in the way of perks, upgrades or property improvements. Rent went up every year. And owners could almost do as little as stick a sign in the front yard and have the new tenant move in the front door while the old loaded things out the back.
Times changed. Low interest rates and the boom in housing wreaked havoc on vacancy rates. Qualifying for home loans was comparatively easy. It made more sense for a tenant with a good credit score to buy a property rather than rent. After all, that way he or she could realize the tax benefits and appreciation that come with property ownership.
Needless to say, vacancy rates skyrocketed. While low compared to U.S. markets, the cities of Minneapolis and St Paul spiked to seven and eight percent, while the outer ring suburbs saw double digit numbers in several types of units.
To attract tenants, landlords started offering incentives. If a renter signed a one-year lease, he might get the first month free. Some landlords gave away televisions, free cable, and when all else failed, decreased the amount of rent until someone decided to move in. Rent increases became almost unheard of.
Here’s the good news about today’s down real estate market. Fewer people are buying houses. Some are even losing their houses to foreclosure. Those folks still need places to live. So they rent. Demand goes up, and inevitably, so does rent.
In the tight credit market, it’s also more difficult for people to get loans. Which means there are fewer buyers for rental properties, which means purchase prices are going down.
Translation? In the short term, I’m seeing small multi-family properties on the market with very good cash flows. In the longer term, those properties will appreciate rapidly when the market rebounds. (And c’mon — in all the negative press, name one single pundit who’s said it’s never coming back!)
Seems like the best of all worlds if you’re an investor.
Comments Off on Free Is Good
Once upon a time, well, not that long ago, most of the landlords I knew used a couple of tried and true ways of filling a vacant unit: print ads and yard signs.
In college, I worked part time in the classified ads department of a major metropolitan newspaper. There was no such thing as taking Friday night off, because that was the last opportunity for people to get their Sunday ads in before the deadline. We were there until 9 and the phones never stopped. After all, didn’t everybody consult the Sunday classifieds when the were looking for apartments? Cars? A used drum set?
We’ve all heard how the daily newspapers are struggling to stay afloat. The Internet has become the “go to” place for many of us for news, weather and a calendar of happenings.
I learned this the hard way. That’s where renters are looking too.
For weeks I advertised a unique property in the local paper: to the tune of $100/Sunday (and they wonder why nobody’s advertising). On a good week, I’d get two calls. I spent hundreds of dollars trying to chase down a tenant. Nothing. Not only was I out the ad money, I was out rent too.
Out of desperation, I tried Craig’s List. I had over 30 inquiries in a matter of hours. Close to 100 overall. And it was free. The downside? Fielding all of those e-mails (the property wasn’t right for everyone).
Since then, I’ve spoken with a number of friends and clients who own income property. They’ve all had remarkably similar experiences.
The lesson? Why pay for terrible when free works better?