Thank you to all our fantastic clients for helping us have a great year and trusting us with your financing needs. 

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Bank of America released its plan to handle some of its REOs.  They will be testing an REO to rental strategy.  This one sounds like the Fannie Mae initiative to sell properties in bulk, but is in fact much, much different.  Bank of America is trying to handle the REOs before they actually become REOs by offering to rent the property back to the borrower if they sign a deed in lieu of foreclosure.  So basically the defaulting borrower would sign ownership of their home back to Bank of America who will then lease the property back to the borrower at or below market rent.  They will be using management companies to collect the rent and take care of the properties.  This is going to be tested in New York, Nevada, and Arizona and if all goes well, will be released nationally.  They also mentioned that if this does work, they will offer some REOs in bulk, much like the current Fannie Mae program, as long as the buyer agrees to leave the current renter in the home for at least three years.  After three years, the tenant is ready to buy again and the hope is they buy their own home back.  This could be a solid investment with a readymade tenant buyer.   My guess is that the packages of properties will be too large for smaller investors, but this could be something to keep our eye on. 

Investors are helping in the housing recovery.  Well this is nothing new, but is finally starting to get more attention.  Even NAR (National Association of Realtors) is trying to get lenders to loosen up investor guidelines to help investors buy more.  Recent statistics claim that investor activity is up 65% from this time in 2010.   Our buying window has already started to close, but this is still a great time to buy.  If you are still on the sidelines you will regret not taking action.  Warren Buffet is extremely bullish on single family homes.  In fact, he said if he could manage them he would buy a million single family homes right now.   You have probably been getting pounded on from every Realtor and lender you know, but there is a reason.  This truly is a great time so take advantage.

Self Directed IRA

Here is an article that our friends at New Direction IRA wrote for us a while back…

Many people don’t know that an IRA (or Roth, I-401k, HSA) can partner with other investors or, with care, the IRA holder.  There are several ways to do this, some easier than others.  The question frequently asked is “if an IRA holder cannot have a transaction with his/her IRA, how is it they can purchase an asset together, isn’t that co-mingling of funds?”  The answer to that question is that they can partner, each with their distinct and defined share of the investment.   Neither funds nor equity may not shift back and forth between the IRA and the IRA holder within the investment as that would be co-mingling and violate the rules. 

Why do people partner?  Sometimes the IRA is not big enough to purchase an asset and wants to join other investors.  Sometimes an investment will be put together and structured to include IRAs as investors.   Most frequently we’ve seen partnering happening in real estate transactions and private lending by using self-directed IRAs. 

The various partnering combinations seen are:

1. IRA partners with arms length cash investor (easy)
2. IRA partners with arms length IRA investor  (somewhat easy)
3. IRA partners with close family member* cash  (more difficult)
4. IRA partners with IRA holder (can be complicated)
5. IRA partners with IRA of close family member (can be complicated)
6. IRA partners with Roth IRA belonging to the same person  (the most difficult)

What are the important differences in these six combinations?  Combinations #1 and #2 are easier because they involve people or IRAs that belong to two unrelated people. 

There is a lot of flexibility in #1 because the arms length cash investor can handle the funds of the partnership and does not have to worry about shifts in equity or money between him/her and the IRA. 

In #2, since they are both IRAs, neither of the IRA holders can handle the funds of the asset and must use a third party.  Since IRAs have contribution limits, if the partnership runs out of money there may have trouble in the event of a cash shortfall and the IRAs may not rely on the IRA holders to bail them out.  The good news is that if one of the IRAs has sufficient cash, that cash can go in and bail out the investment without violating any rules.

Combinations #3, 4 and 5 are the same.  No partner can handle the money, no partner can pay the expenses of the other partner in the event of a cash shortfall and there can be absolutely no shift in the cash or equity balance between the partners.

What about #6?  Why is that so difficult?  Well, when you partner your traditional IRA with your Roth IRA, everything stated in the paragraph above applies plus, because the aggregate contribution to BOTH IRAs cannot exceed the current 2011 $5,000 limit.  You have less ability to contribute.  An additional burden placed on this partnership is that you may not always qualify for a Roth IRA because you make too much money.  In this case, as in all the combinations above, you must have earned income in order to make a contribution.  If you make only $5,000 for the tax year, your contribution may be only $5,000.

Other investments in which partnering works, and probably the easiset of all, are in private lending.  Without going into how these deals are structured it’s enough to say that “arms length” lending of money, either as a first or second deed of trust, can include all of the combinations described above in #1 through 6 without issue.

Here are some examples of partnered investments:

Example #1

Lloyd and Bruce each have a self-directed IRA and live next door to each other.  On their street is a property on the market and which they think is a good deal.  They don’t have cash individually but they have IRAs that can manage the purchase.  The IRAs turn it into a rental property and engage a property manager because neither Lloyd nor Bruce can handle the money.  They decide to do a cosmetic remodel at a cost of $12,000 and sell the property within the first two years.  Both Lloyd and Bruce are over 50 and therefore can contribute $6,000 each over a two year period thus having another $24,000 available for the remodel.

Example #2

The McCarthy family members have $200,000 collectively in their self-directed IRA accounts.  Although each of the four IRAs has only $50,000, together they are able to lend the money as a first deed of trust on the purchase of a rental property by an unrelated third party.  They negotiate the terms of the note; obtain title insurance, an appraisal, make sure the IRAs are shown as the mortgagees on the hazard insurance and hire an attorney to put together the note and deed of trust.  The borrower pays all of these expenses in addition to a 1 point origination fee.  Mortgage checks are sent directly to the self-directed IRA administrator and tracked using the clients’ on line statements.

In conclusion, consider the power of partnering IRA funds with other IRAs or individuals.  It can be done in real estate purchases with varying degrees of difficulty and done quite easily in private lending of all types.  There is no limit, from an IRS standpoint, on either the terms negotiated by the IRA for lending or the number of IRAs that can participate in an investment.  Consult with your tax and legal advisors when considering any investment in your IRA.  For information on the rules and for self-directed IRA services for this type of IRA investment, visit www.newdirectionira.com.

Warren Buffet Likes Real Estate Now

tenant screening

It is no secret that right now is a great time to own rental homes for both cash flow AND appreciation.  When I ask rental property owners to explain their asset most will start telling me about the physical property.  I disagree.  Your biggest asset is your tenant.  Because finding a good tenant is so important I want to talk about some of the high risk tenants that I have encountered.  You have to be very careful here as these could be protected classes and I am not saying not to rent to anyone on this list.  I am simply pointing out that these could be a higher than average risk for you as a property owner.  Please do not discriminate against a protected class. 

1)       People that have never lived together – You will normally see this with younger people.  Often times they have recently left home and need roommates to help cover some of their costs.  This is exactly what I did.  The biggest problem here is that people that have never lived together soon learn that they can’t.  You know what I am talking about; one is a slob, one stays up partying too late, one does not cover their portion of the bills, and this list can go on and on.  Trust me if they don’t get along and one moves out you will soon find yourself with a vacancy and possibly one that is returned in less than desirable condition. 

2)      Recent marital change – Again be careful here as this is a protected class.  As we know many marriages end in divorce and often times it is not pretty.  If a divorce is going to happen it may happen sooner than later so a recent marriage can be risky but the biggest issue here is a recent divorce.  One of two things could happen with a divorce and one of the two moves into your house or apartment. 

1. They don’t get along and the ex spouse comes over causing problems after they have had a few drinks.  The next thing you know the neighbor is calling saying the cops are at your house again. 
2. Or even worse, they decide to get back together.  J  I know I’m so harsh.  When they get back together what do you think is going to happen?… that’s right, you have another vacancy. 

3)      Self Employed – I hate to say this since I am self employed but the fact is most small businesses go out of business.  If you are reading this you don’t fall in that category.   J  Have you ever rented to a contractor or handyman?  I have several times with less than desirable luck.  Most small business owners are great at what they do but aren’t so great at running a business.  They don’t understand how to generate business and how to keep the income coming in.  They get busy doing what they do and when it is done they don’t have anything to do.  Make since?  If they do run their own business be sure to ask them questions about how they generate leads and how they keep their cash flow positive.   Also ask for a business card to help verify that they are really not self unemployed. 

4)      Recent job change or recent residents change – This is especially true if there has been more than one in the last 24 months.  This is an indication of instability meaning unstable in your rent also.  Often times they will not disclose many jobs or resident changes on the application which is why calling the last two landlords and asking how long they have lived there is important.  Also, many times recent addresses will show up on the credit report so you can use that to verify missing information. 

Please use this information for what it is worth.  It is not a reason to deny a prospect but is a good way to raise red flags and to be extra careful with the screening process.   Good luck!

Here are the top five ways to save money on your rehabs:

1. Have a solid plan and a budget.  You want to be as clear and detailed as possible.  Your contractors can help you with this during your diligence process, but you want to use your own numbers and not just what the contractor tells you.  You will also want to include a contingency for anything you don’t see before you start, or for items that end up costing more than you thought.  It is important to know what you are going to do and what it should cost before you buy the house.
2. Pay with a debit or credit card that includes a discount or a rebate.  For example, Lowes offers a 5% discount on all purchases using their card.  You also might have a major credit card that gives you cash back or other reward program.
3. Buy in bulk.  If you are doing a lot of projects this is easy, and you are probably already doing this.  If you are just getting going or only doing a couple deals a year, this can be more challenging.  My suggestion is to find some designs that are natural and popular and get a group of investors to go in on buying the material.  For example, maybe there is a specific tile or granite that you like and plan to use in your projects.  If you get a group of investors together all working on a project, you can team up to get the best deals.  A great place to find investors doing deals is networking on and offline.  The Pine Financial Group Happy Hour is a great place to meet local and active investors.    
4. Look for sales and stock up.  I remember my grandma buying cases of toilet paper, paper towels and anything else that did not expire, when it was on sale.  Heck, she would even buy things that did expire if she thought it was a great deal.  This is a solid strategy for business too.  As long as you have a place to store them, buy things you know you will use, like outlet covers, light fixtures, and plumbing fixtures, when they are on sale. 
5. Negotiate with contractors.  When you are just getting going, have several contractors show up at the same time to bid your job.  This will save you time by walking through the project only once and it will create a competitive environment.  This might be uncomfortable for you, but it will be profitable.  Once you start getting bids in, you can call them back and ask them to do better.  Contractors will hate this, but it is a great way for you to save some money and they can always tell you no.  Once you become more experienced and you start learning what certain items cost, you can set the price and call contractors and ask them if they can get it done for that price.  I have a house in Colorado Springs that needed a new electrical box and the box had to be moved.  I know that a price of $1,500 including the permit is profitable for the electrician but is a great deal for me.  I did not know any electricians in the Springs, so I started asking for referrals.  When the referrals starting coming in; I sent them to the house and told them I would not pay more than $1,500.  The third electrician that looked at it wanted the work, and I got what I needed for the price I wanted.   

Straw Buyer

Do this and you can lose everything or maybe in even end up in jail.  There is a very fine line between using or being a straw buyer and partnerships.  I think the best distinction is if all partners actively participate in the deals.  Here is what I mean.  I straw buyer is someone who provides credit to a partnership for a fee.  A typical example is when Ivy Investor wants to build a rental portfolio but cannot qualify for loans.  She pays Carl Credit $10,000 to buy a house and deed it to her.  In this example Carl has no intention of making payments on the loan because Ivy has promised to do that.  

I have been spending a lot of time of subject-to investing where a seller deeds their property to a real estate investor.  That is not illegal.  What makes the scenario above illegal is the intent when taking out the loan.  Carl’s intent was to deed his property to someone else and never make payments. 

This exact scenario has happened to people I know in Denver.  They were paid $10,000 and sometimes more to use their credit to buy properties.  Here is what actually happened so you get a feel for how dangerous this is.  The straw buyer purchased the homes from the investor group at full price.  The buyer then deeded the property right back to the investor group.  The investor group was able to pull all the equity out of the house using this strategy and then stopped making payments on the loan.  The straw buyer was than stuck because their credit was being destroyed but there was nothing they could do since they no longer owned the house.  It put them into bankruptcy and the happy investors got off Scott free.   I like to call this a win/lose case.  There was clearly a winner, the investor group, and there was clearly a loser, the straw buyer.  Many teams these scams end in a lose/lose scenario.  Obviously the straw buyer loses when they go bankrupt but the investor will also lose when they end up in prison.  If you have time I encourage you to Google straw buyer and read about some of the recent cases. 

The correct way to use someone else’s credit is to actually make them a partner.  They bring the credit you bring value in the way of a great deal or experience or hard work.  Combine it is a winning partnership and you divide the profits AND losses.  All partners also must meet and play a part in major decisions.  There are several ways to structure your agreement but what is important is the credit partner stays involved with the deal making them a true partner and not a straw buyer. 

Credit partners are a fantastic way to reach goals.  Partnerships really should help everyone involved and often times they do.  Do not shy away from partnerships but please proceed with caution.