My eyes are starting to water as I write this article.  This was the last story I heard about someone losing their money by a bogus investment. These are the stories I hear almost every week but this was especially sad because this lady could not afford to have her money stolen from her and now could lose everything.

How do you protect yourself from a person or an investment that is not legitimate when the person selling it to you sounds so smooth and educated?  How do you know if your money is safe?

Before you make an investment like this it is important to understand what exactly you are getting for your money.  Most of the time these investments are private equity.  This simply means that the owners (the equity) are from private people and not an institution.   The person putting the deal together is normally a private person too.  Equity investments carry a certain degree of risk with them.  With equity there is no guarantee of anything, in fact if things go bad you will be the last paid.  For example if the project goes bad and ends up getting liquidated the order in which investors are paid back their investments is:

1. Secured creditor (normally banks or investors making a loan secured by an asset)
2. Unsecured creditor
3. Preferred equity holder (this is not as common)
4. Common equity

It is possible to lose all your money as an equity investor because there is nothing left when everyone else is paid off.

I don’t dislike equity investments at all.  In fact that is exactly how I structured our mortgage fund but it is important to understand the good and the bad.  The good part of an equity position is that you get a portion of all the profits the venture or company makes so your returns are generally much higher.  You are subject to the risks of the company so if the company makes smart investments it is a smart investment for you.

If you are buying equity your will generally either get stock in the company or membership interest in a partnership or LLC.   Your diligence should first understand what it is you are buying and then what the company, partnership or LLC does with your money.  You will probably want to see a track record and maybe look at some past deals.  In our example above the equity investor was told that she would be secured by real estate.  In this case she should have look at other projects completed by this group and checked public records on the county websites to be sure she is being told the truth.  She could have also asked to see recorded documents with the county’s recording information on it.   She will also want to check into the person that is offering the investment.  Background checks are a good idea and a track record for the individual is a good idea.  If the person has a license through the state the background check and employment and residence history has already been looked into by the state.  Not having a license does not mean that they are bad people or doing something illegal but it will require further investigation by you.  Again in our example it was later discovered that the person with the opportunity had a criminal history that was not disclosed.

Here is a list of steps that I would take and questions I would ask when looking at a private equity investment:

1. Do I understand what I am buying (units in an LLC, stock, etc.)
2. How does the investment work?  How does it generate income, how does it pay its investors, when does it pay, what are the risks and expected returns.  This is all the basic stuff you should know and weigh the rewards to the risks.  This should be easy because it should be disclosed to you.
3. How do I know the person selling this to me and should I be able to trust them?
4. How long has the person been in business or at least doing this type of investment?
5. Do they carry any licensing to do this and can I verify that? If not you should check criminal record to be sure they have not stolen money in the past.
6. What is the track record for the investment and the person selling it to me?
7. Can I talk to some current investors?
8. Do the principals and sales people have money invested in it?

I really believe that you should go through each question/step before you commit to doing any business with them.  If it is an option you might also consider investing a smaller amount at first and add to it later.  This however is not always possible.

Be careful out there but don’t be afraid to make investments and reach your goals.

Stay Safe

Hard Money: Why Savvy Investors Use It

Learn Successful Financing Secrets

Are you passing on profitable deals because you are not sure how to finance it or don’t think you have the money to do it? Would you make more offers and do more deals if you have virtually unlimited financing?
• Why and how savvy investors use hard money
• How to make offers with confidence knowing your financing will come through
• How to create a cash flowing portfolio with little or no down payments
• How to use portfolio lenders to increase your rental portfolio
• Interested in raising private money? Learn why it is a great idea and why you need to be careful.
• Learn why many successful investors become lenders themselves and some common pitfalls to avoid.
In this class you will learn about hard and private money and why it is a tool that has made Kevin and hundreds of clients successful real estate investors. You will also learn some key points to raising and lending private money and how to be successful and safe on either sides of the transaction.

Who should listen and why:

Experienced and beginning real estate investors wanting to better understand the current financing landscape
Real estate and mortgage professionals looking for more ways to help their clients and close more deals
Anyone in looking for better ways to finance their financial future

Register HERE

I can’t tell you how nice it is to know exactly who I am going to call no matter what the issue is that comes up.  This virtually eliminates stress from my life and allows me to handle any problems no matter where I am.

Here is a partial list of professionals that will help insure your success:

• Realtor
• Mortgage broker/banker/other funding sources
• Attorney (you might have several attorneys)
• Accountant
• Insurance broker
• Contractor/handyman
• Property manager

Here is a quick list of important qualification when choosing team members:

They invest in real estate– You need someone that understands what you are doing and that has experience in the industry.  Just because your neighbor is a realtor with 20 years experience does not mean that he understands investing and the different strategies that will help make you rich.  People who are doing what you are doing will be the best to give you sound advice.

Care about your goals – When you speak to a possible team member see if they ask you about your goals and what it is you are trying to accomplish.  Someone who does all the talking and none of the listening is obviously in the business for their benefit and probably does not care if you reach your goals or not.   Occasionally Travis or I will tell a client that the deal they are working on is not a deal at all.  We walk them through the numbers and show them why they need to pass.  Often they get angry at us because they are emotional about the deal but will call us several months later to say thank you.   Be sure the potential team member wants you to succeed and is not just trying to get a commission.

Qualified – This is pretty self explanatory.  If they say they are a Realtor you may want to be sure they are.  I like working with the best so often times I will ask for referrals and verify those and inquire about how long they have been in business.   They best way to find team members is referrals from other successful real estate investors.

Reasonable fees – Don’t be cheap but don’t pay someone more than the going rate for their service.  This should be easy to verify online.  When I say don’t be cheap I mean it, many times you will get what you pay for.  There are expenses related to running this business just like any other business so be prepared to pay your team members.

Chemistry – You are not getting married here but you want to work with someone you can stand to be around.  Ask yourself if you like the person and can handle spending time with them.  Do you feel the feeling is mutual?  You will also want to ask if you can trust them.

Be sure to join us at one of our networking meetings to start or continue building your team.

If you know me you know that I love rental property and believe that it should play a role in most people’s long term wealth goals.  Many people struggle with how to run numbers of potential rental acquisitions so I posted a form you can use on our free resources page of our website.  The second page of the max offer worksheet walks through how to analyze a deal if you plan to keep it and rent it.  In this article I will explain how to use that worksheet.

This is a form that I use but it may not be the best one for you to use in your business. It should, however, be a great start.  The reason I say that is because my buying strategy may differ from yours.  When I buy a property to hold I have very little concern with speculation on appreciation.  In the past I would buy property in nice areas to hold even if I lost money each month in hopes that values in that area would increase.  I learned some painful lessons with my flawed strategy.  Now I only buy hold properties that will cash flow, period.

It might be a great idea to use hard money to get into a property for little or no money down.  Once it is rehabbed and there is a tenant in place you can refinance the hard money into a permanent loan.   This form is primarily used for that exact strategy.

Once you have a deal in mind you will need to calculate what your max loan amount can be in order to accomplish the cash flow you need to make the deal work.  From there you can work backwards to your offer price.   To calculate the max loan, start with the monthly rent.  You get this number from a rent analysis that you or a management company you work with will perform.  One way to do this is to drive the area and call all the rental signs to see what other people are asking for rent.  Keep in mind that this is not a bullet proof formula for success but it is the way I do it.  Sometimes people are asking a higher rent amount than they will actually get.

From the monthly rent you need to determine the net operating income by subtracting the following variables: vacancy, maintenance, taxes and insurance.  There are a lot of variations to the variables depending on what type of property you are analyzing.  For this discussion we are going to be looking at single family detached housing.

Vacancy – you are going to think you are better at keeping your units full than you actually are.  Be conservative here.  I use between 5-10% of gross rent depending on the neighborhood but sometimes that is even low.  Worse areas have higher turnover.

Maintenance – This depends greatly on the type of tenant you end up with.  If you sell your homes on a rent to own you might think you will have no maintenance, but I promise you will.  If it is a normal tenant in a low income area your maintenance can be quite high.  Use 5-10% of gross rent for a good tenant on a rent to own and use 10-15% of gross rent for other tenants.  It should not be much higher than that on a single family home.

Taxes and Insurance – These are most likely quoted on an annual basis so simply divide by 12 and use that number.

From the NOI you need to subtract your required cash flow to determine what monthly mortgage payment you are willing to pay.

Monthly Rent ________________

-          Vacancy __________________

-          Maintenance ________________

-          Taxes and Insurance (TI) _______________

= NOI ____________________

-          Required cash flow ___________________

= Max principal and interest payment _____________________________

In the past, most loans that I would get were interest only loans so I used a formula using the maximum monthly payment to come up with a maximum loan amount.  The formula was to annualize the monthly payment by multiplying by 12 and then dividing by the interest rate.  That was the easiest way to do the math.  Now it is very difficult to get interest only loans so you should be looking at the math using a standard mortgage.  The best way I have found to do this is with loan calculating software.  I like this one http://www.bretwhissel.net/cgi-bin/amortize .  To make this work you want to leave the Principal and the balloon fields blank and complete everything else.  When you hit the calculate button it will give you the loan amount using the interest rate and monthly payment.   Interest rates are changing each day and sometimes several times a day so get an idea from your loan originator what the rates will be and add a little cushion in case rates increase by the time you refinance.

This is where the worksheet stops helping you but you are obviously not done.  Print this newsletter and keep it for your reference.  From the maximum loan amount subtract closing costs for the refinance which should not exceed 3% of the loan amount.  You can have your loan originator help you with this number.  The result of subtracting the closing costs leaves you with the hard money loan amount in which you will be refinancing.  Ideally you want your hard money loan to cover as much of the deal as possible so you need to subtract the repairs and the closing costs from this number to come up with the offer price:

Maximum Loan ___________________ (from the worksheet)

-          Refinance costs _____________________ 2-3% of refinance loan amount

= Hard money loan _______________________

-          Repairs ________________________

-          Closing cost to buy _________________________ (4% plus $1,500)

= Offer price ______________________________

The final step is to be sure you can get the hard money loan for the amount you are hoping for.  You do this by dividing the hard money loan amount from above by 70%.  The value of the property needs to exceed this number for the deal to work.  For example, if you are hoping for a loan in the amount of $100,000 the value of the property would need to be $143,000.  100,000 / 70% = 143,000.

Often times the deal is strong from a cash flow perspective but there is not enough value to borrow all the acquisition costs in the hard money loan.  If this is the case and you decide to move forward based on cash flow potential you will most likely need a down payment for the hard money loan but will not need any additional cash for your refinance.   Contact your hard money lender for help with the down payment amount.

It is much more difficult to analyze a deal’s cash flow because there are many more variables and often times two loans.  If you are not using hard money it is a little easier but you will need to add your down payment amount to the maximum loan amount from your worksheet to come up with the offer price.  Although this can be very confusing, I am confident that you can get comfortable looking at deals this way with practice.  Although I might not have time to answer everyone please feel free to ask questions.  If I get several questions I may include something in next month’s issue with the most popular questions and my responses.   Interest rates are ridiculously low making it is a great time to buy rental property.

Last year we had an expert panel at our Denver Happy Hour.  These are some of the best and most active investors in the area.   All of them have done very, very well for themselves.  The last question that I asked the panel was “what is the stupidest thing you have done as a real estate investor?”  Charles Roberts, one of the current owners of Your Castle Real Estate and long time investor, said his biggest mistake was going over his budget on is first rehab by 600%.  He than said he dared the audience to top that.  That is pretty bad but check out my dumbest real estate moments:

My first short sale

I was just getting started learning as much as I could.  I fell for a sales pitch at one of those seminars where the speakers promote their products.  I purchased a short sale product which promised I would be rich in no time.  The program taught me to get the seller to sign a deed putting the property in my name before I negotiated with the bank.  The seller wanted $3,000 for title to his house so I asked my best friend for $2,000 and I did a cash advance for the $1,000 and I gave the seller the money.  My friend and I started to clean up the property while I worked the short sale.  Of course the short sale was not as easy as the home study course promised and the bank declined our offer and foreclosed.  We obviously lost our time and money and I almost lost a friend.

Not screening a tenant

You may know that I got started in this business by moving out of the first house I owned to keep it as a rental.  What you might not know my first tenant in that property is still the worst tenant I ever had.   This mistake was before Stephanie was helping me with the business or we may have never gotten married.  I was just so excited to have an application for my first rental property that I just approved them with no screening.  The result was an ugly eviction, damage to the property and the worst roach infestation that I have ever seen.   I had to use a line of credit to turn this property over which took me several years to pay off.   I could have easily lost this property because of this mistake.

Goals set by number of houses

It is amazing that I stayed in the business after the first two mistakes but I did and here is what happened next.  We are all taught to make goals and do everything we can to reach our goals.  Well that is exactly what Steph and I did early in our career.   Our goal was to do at least 12 deals a year.  Not necessarily a bad goal but maybe we should have been more clear.  Our goal should be 12 GOOD deals a year.

We were so motivated to build a large portfolio betting that they would appreciate that we took on deals with negative cash flow.   We hit our goal year after year and were doing ok but you can probably already see where this story goes.  I still have properties today that I lose money every month and now I am upside down.  It will take years of appreciation if there is any hope of even breaking even (if that is even possible).  If I was to sell them today I will lose as much as $50,000 on a single deal.  Going forward we only buy for cash flow and don’t bet on things we cant control like appreciation.  We also set much smarter goals.

The three year lease purchase

For purposes of this article I would like to separate a lease purchase and a lease option.  In my opinion a lease purchase is an agreement where you agree to buy the house while a lease option gives you the right to buy the house or not buy the house.  I will never promise to buy a house on a lease option again and I will never do a short term lease option.  I think this was our third or forth lease option deal and it appeared to be a good deal with our diligence with one exception.  The seller offered decent terms but wanted us to promise to buy the house after three years so that they did not have to pay capital gains taxes on the sale of their home.  We agreed.

After three years the house went down in value and would not appraise.  This was before appraiser independence so we were allowed to communicate with the appraiser.  We promised to purchase this home so I was going to do whatever it took to live up to my obligation.  I was able to locate some solid data and I worked with the appraiser to get the value higher enough to get my loan.  I did have to purchase it for more than it was worth even with the higher appraisal so Steph and I brought a larger down payment than we should have needed to.  After we purchased the home it continued to decline in value and rents went down.  By the time the dust settled we lost more than $40,000.

Straw buyer

This might be the dumbest thing we have ever done and I am embarrassed to say might top any of the panelists last month.   We had partnered with Chris during our first year as an investor.  We flipped a house together where we each made more than $17,000.  In fact that $17,000 was my first profitable deal and is probably the reason I stayed in the business after my nightmare tenant and my failed short sale.   We trusted Chris and he had proven he can make money in this business.

Several years after our success experience with him he asked us for help.  He was hurting for money but we did not know it.  He asked us to buy one of his rentals for him for top dollar and deed it back to him.  He said he needed to get it off his credit report so he can buy more houses.  To compensate us for this favor he paid us $10,000 (which we desperately needed).  He had a tenant in place.

Well he stopped making payments on the loan and would not call us back.  We started making the payment and collecting rent from the tenant in an effort to save our credit.  The tenant got further and further behind but we could not kick him out because we knew the house needed more work than we had reserves to handle.  It finally came to where the tenant took advantage of our lenience and stopped making payments completely.  We had no choice but to evict.

Once he was out we tried to clean the place up but had no money.  We worked on it ourselves but there were major issues.  We also tried to do a rent to own as a handyman special since we did not have the money to make the repairs.  No one wanted it and we could no longer make the payments.  This deal put an amazing amount of strain on my relationship with Steph and we ended up losing that house.

I know that some of these mistakes are so dumb that you would probably never make them.  My hope is that by sharing these with you, you can find a way to learn from them and becoming a better investor.

It is true that all of these issues could arise.  The reason I am a huge advocate of rent to own is that you can eliminate 95% of these calls.  It is VERY rare for me to get a phone call asking for maintenance help on any of my rent to own properties.

When I I fill my properties with rent to own tenants I take a three prong approach to handling maintenance issues.

1. Be clear at the lease signing
2. Maintenance Request forms
3. Taking the phone call

Be clear at the lease signing

When I sign the lease with the tenant I go very slow with two section of my lease.  When the payments are due and what happens when it is late AND how we deal with maintenance.  My lease states that the tenant is responsible for ALL maintenance.  When I hit this section I explain it like this:

Me: Mr and Mrs Tenant, you really want to own this house right?

Tenant – Yes

Me – Do you understand that you are buying this property using a rent to own and that I am working with you to own this house?

Tenant – Yes

Me – Since you are buying this house you are going to be responsible for the maintenance.  With that being said, if there is a major problem I want you to let me know and maybe I will be able to help you out with the cost.  But other than a major problem I don’t want phone call with maintenance issues. Is that fair?

Tenant – Yep

At the time of the lease signing the Tenant is in their best mood and is excited about the house so they will happily agree to this.

Maintenance Request forms

One of the last forms I give the tenant after the lease is signed is my Maintenance Request Form.  This is the form that I require my tenant give me when they have a maintenance request.  By forcing the requests in writing it helps me be sure the issue is resolved and provides a paper trail of all requests and actions taken.  It also prevents minor maintenance issues because often times the Tenant will lose this form and would rather fix the issue themselves than to tell me they are not responsible and lost the form.

When I get to the point I am handing them this form I explain that they can call me if they need to but that I will ask them to complete this form if there is a major maintenance problem.  I again tell them this is only for major issues and to be sure to save it because I don’t respond to maintenance requests unless I have them in writing.

Taking the phone call

When I do get a call I ask them to explain what the issue is.  If it is something major I simply ask them to send in the Maintenance Request form at which time I will handle the issue.  If it is something that will cost less than $200 or $300 I explain that this is not really a major problem and I remind them that they agreed to handle these problems.  If I get some push back I might ask them if they would rather convert to a normal tenant landlord relationship and lose their rent credits each month.   In no case will I ever handle the maintenance issue myself unless it is a health or safety concern and they tell me they are not going to fix it.  I might send them a referral and agree to pay for half but it is their responsibility to be sure it is repaired.  This will save you a lot of headache dealing with contractors yourself.

This is a very important distinction because through my 11 years in the business I have seen people that have made a lot of money flipping houses lose everything.  The lost it all because their life style adjusted to their income level.  All the money they made was being spent to support their life style and none of it was actually being invested.  I big part of preparing for the future or just a potential rainy day is to put money away.  The most successful people I have ever met or had the pleasure to talk to have an income generator (or several) and they invest their income in real estate and other options that will both produce passive income and future growth.  Real estate just happens to be one of the best options that can produce income and growth.

If you agree with what I am saying than you should have a two prong attach with your real estate career.  Obviously you need income to live and to have money to invest so flipping houses can be a big part of that AND you should be buying rental property to generate additional income streams and growth for later.

hard money lender

It is possible that banks once again will tighten up lending in 2013 in the wake of fiscal uncertainty. Hard money loans from private money, non-bank lenders could once again be the solution for credit in 2013.

Hard money lenders have had to fill the gap in lending since 2008, when we hit our credit crunch and banks stops lending money. Because hard money loans come from private investors and not from banks, hard money lenders do not fall under the same regulatory and operational requirements that banks are forced to comply with. There is a lot more flexibility when the Government is not so involved in your business. In fact, in spite of our Government, hard money lenders is the primary reason we were able to dig ourselves out of our housing crises as quickly as we did. They were lending on foreclosed properties in 2008 and 2009 when banks were not.

We believe that banks will continue and may even get more conservative when it comes to lending on investment properties in 2013. As underwriting seems to get a little more relaxed for owner occupied borrowers, we have not seen that for real estate investors. This is the main reason many borrowers have turned to hard money lenders to obtain loans for investment property purchases and refinances.

Hard money lenders can be much more aggressive and loan higher loan to values than banks or other traditional lenders. Not to mention they can close extremely fast. They can also loan on properties in disrepair, in fact most hard money lenders want to loan on properties that need rehabbed. Even though fees and rates are much higher with hard money lenders, it is a much needed source of credit.

Real Estate News

The housing market recovery should continue through the coming years, assuming there are no further limitations on the availability of mortgage credit or a “fiscal cliff,” according to forecast presentations at a residential forum for the 2012 Realtors^® Conference and Expo.

Lawrence Yun , chief economist of the National Association of Realtors^®, said the housing market clearly turned around in 2012. “Existing-home sales, new-home sales and housing starts are all recording notable gains this year in contrast with suppressed activity in the previous four years, and all of the major home price measures are showing sustained increases,” he said.

Yun sees no threatening signs for inflation in 2013, but projects it to be in the range of 4 to 6 percent by 2015. “The huge federal budget deficit is likely to push up borrowing costs and raise inflation well above 2 percent,” he said.

Rising rents, quantitative easing (the printing of money), federal spending outpacing revenue, and a national debt equal to roughly 10 percent of Gross Domestic Product are all raising inflationary pressures.

With rising demand and an ongoing decline in housing inventory, Yun expects meaningfully higher home prices. The national median existing-home price should rise 6.0 percent to $176,100 for all of 2012, and increase another 5.1 percent next year to $185,200; comparable gains are seen in 2014.

“Real estate will be a hedge against inflation, with values rising 15 percent cumulatively over the next three years, also meaning there will be fewer upside-down home owners,” Yun said. “Today is a perfect opportunity for moderate-income renters to become successful home owners, but stringent mortgage credit conditions are holding them back.”

“People who purchased homes at low prices in the past couple years, including many investors, can expect healthy growth in home equity over the next four years, while renters who were unable to get into the market will be in a weaker position because they are unable to accumulate wealth,” he said. “Not only will renters miss out on the price gains, but they’ll also face rents rising at faster rates.”