All Forum Posts by: Samuel DeMass

BP wizards,

I once again call on your wisdom.

I'm bringing a project manager in on a deal to manage a rehab that has two end-games, Flip or rental.  He's new to real estate, but my requirements are fairly low, and I'd like to develop a good professional working relationship since he's becoming a realtor in one of my markets.

The project manager will be my eyes and ears (weekly pictures, coordination of contractors, and brief email summary of progress).  He will have no equity position in the property or deal, until the sales closing is complete.  I'm drafting the operating agreement now.

The compensation agreement is we will split all profits 50/50 after the cash I input is paid back at 112% (12% earned), and he gets to list it as a realtor and make his selling agent commission.

However, if we are unable to sell the house within a year, at a price that puts us above the bottom line, my plan is to convert it to a long term rental hold.

The issue I'm working through is trying to find fair compensation for his efforts if the deal doesn't work out.

Is there a fair way to compensate or a markets standard for this type of transaction?

Thank you for your time.

Cheers,

-Sam

Brad,

Operating income and operating expenses.  Beyond that knowing your market is key.

More specifically for Operating income, find out actual lease terms in place and rent roll.

For the expenses, you can ask for a schedule E to see what they claimed to the gov't, but I suggest estimating your own numbers based on previous experience or a conservative guess.  You can get quotes on almost all recurring expenses (tax, insurance, water, garbage...etc).

Best of luck!

Cheers,

-Sam

@Chris Torbert Glad I could help. BP is my one venue to fill my REI discussion needs. It helps me hash out my thoughts and define them clearly when I get to typing.

Cheers,

-Sam

@Nick Hedberg,

How'd it go?  Did they have cookies?

@Nick Hedberg,

No worries.  I've had nothing but good experiences with courtesy closings.  It usually takes about one time through what you want before they catch on, so don't be surprised if whoever answers the phones doesn't understand what you're asking them to do.

Just let them know you need to schedule a closing at their office.  Tell them it will be an out of state closing, or a courtesy close.  Get their mailing address and mailing instructions if it needs to have anyone's attention denoted on it, so you can pass these details to whomever is mailing the documents to you for signature (assuming you don't want to deal with the hassle yourself).  I usually have them sent direct to the title company and they prep the documents for me before I come in for closing.  Let them know you're happy to pay for their services (and get a feel for how much that will cost). The cost is well worth the smooth closing, and cookies.

Remember that they are just as interested to help you out for the same reasons that you want to use them.  They see future business when you walk through their door.

One last logistics note, call first thing tomorrow!!!!  Don't wait to get a time scheduled that will meet your timeline.  Friday is coming quick, and they don't pay people to be not busy.

Enjoy the cookies.

@Chris Torbert,

Short answer: I'd be looking for the lowest rate I could find on a 5/1 ARM with the amount of cash I had on had being the determiner of the down payment I wanted to pay, balanced with the highest cash on cash returns I could get.

Stupidly long answer:

I feel I should clarify I'm not paid for my financial expertise.  The following is clearly my observations, opinions, and excel calculations.

In my experience 6% is too high for a 5/1 ARM with a 20 year amortization. I tend to think the semantics of 'type' and 'terms' are not entirely relevant. Use language that makes sense.

What you need to settle upon is the structure and rate of the loan that you want, and can afford.

All things being equal, you can get a lower rate on a shorter term loan.

For instance you should get a lower rate on a 3/1 (3 year locked rate followed by a yearly adjustment rate) than you will on a 5/1 (5 year locked rate, followed by a yearly adjustment rate).  This is fairly easy to understand when you look through the bank/lender's eyes.  The 3/1 is actually safer for the lender in case market interest rates start to rise.  It allows them to adjust to increased market and avoid losing out to inflation and opportunity costs.  In other words, if interest rates rise, they only have to stick with that interest rate for 3 years, instead of the 2 extra years a 5/1 would cost them.  Therefore, they are willing to give you a lower rate on a 3/1 than a 5/1.

Ceteris paribus (all other things remaining the same) the same logic and reason can be applied to the amortization length of fixed rate loans (30 year fixed, 20 year fixed, 15 year fixed...etc).  You will find better (lower) rates on a 15 year fixed than a 20 year fixed, and better rates on a 20 than a 30 year fixed.  The logic is the same because exposure time is increased as payback period increases.

Further, you should find that if you compare ARM and fixed rate loans of the same length, or amortization, you will see lower rates on the ARM structure, because they will be able to adjust to market.

I prefer using 5/1 ARM loans. Are they riskier than long term fixed loans? Yes, maybe. Maybe not.

Here's merely my opinion:

My strategy is fairly straight forward: Buy right, and hold forever.

It's worth mentioning that the Buy right portion is the most critical.  The rest truly doesn't matter if you don't buy right.  

Because ARM loans offer lower rates, I use them to produce more cash-flow. I use the cash-flow to re-invest in more properties and repeat the cycle. Simple enough.

Here's where it gets mind bendy and the math gets a little higher than fingers and toes:

Given a 100K purchase at 10% down, on a 30 year loan, lets compare an 5/1 ARM and a fixed:

We'll assume the split is 3.5% and 5.25% for ARM and fixed rate. (note: this may not be 100 accurate to current market splits. I picked these numbers almost at random)

Mortgage Payment:

3.5% 5/1 ARM: $404.14

5.25% fixed: $496.98

Split: $92.84

Split total @ 5 years (60 payments): $5570.59

This is an incredibly important observation, because cash-flow can be easily re-invested elsewhere, principle takes a little more work and effort to move.

Principle paydown:

3.5% 5/1 ARM: $9272.63

5.25% fixed: $7065.46

Split: $2207.17

Total 5 year savings between Principle pay-down and higher cash-flow: $7777.76

At the 5 year mark I tend to think is a good time to evaluate the market and consider your options to include:

-refinancing into another 5/1 ARM to lower mortgage payment

-if the market conditions are real scary, switch to a fixed rate loan.

-if the property has wildly appreciated consider a refi to pull out equity and place elsewhere

-if pulling out equity upsets the cashflow balance, then a 1031 is probably a good idea

In the event of rising market rates, you have paid enough down that you can refinance into another 5/1 ARM and restructure your debt which will help you keep your mortgage payment low, even if you have to take a hit to the principle pay-down.

While you accumulate the savings of a 5/1 ARM and your debt is paid down, your rent should be appreciating too. I don't account for it, but your property value may also appreciate which could help you pull equity out and put it to work in other properties. Other exits would also include a 1031 exchange.

The bottom line is shop around to find a better rate for a loan, and understand the risks and opportunities that you are incurring by making your choice.

I hope you, and many others enjoyed the example as much as I enjoyed throwing it down and nerding out a little.  Let me know if there are questions or observations!

Cheers,

-Sam

Nick,

I don't have any specific names to pass, but I like to use title companies that I do other business with, or intend to do more business with in the future.  I'm not sure if you're familiar, but they call it a "courtesy closing".  They'll charge you a small fee (I've observed a couple hundred normally), but they have a few benefits:

-they act as the notary

-they're used to doing closings and can answer questions that may come up

-they usually have a good network of folks in the game

-probably the biggest selling point...they usually have free cookies, water, and pens

Good luck, and congrats!

Cheers,

-Sam

Chris,

I stumbled across this thread and noticed your saying you were quoted 6% on a 5/1 ARM. Too high. Find a new lender or negotiate.

Cheers,

-Sam

Michael,

It sounds like you're heading in the right direction.  First a couple observations that might help vector your efforts:

1. Property Tax needs to be considered as a normal operating expense.  Income tax is something else entirely.  The reason I mention it is when you said "we will be looking at $4k a year from this property before taxes without raising rents etc (they are rising around $25 per year for the last 3 years)."  I don't know what the taxes are for this property, but I'd ballpark ~3-4K?  That means you'd possibly be paying out pocket for this expense.

2.  When analyzing the deal, I would suggest acting as if you were not planning on living there.  This lets you look at the property objectively, and plan for the future when you decide to move on, but hang onto the property.

3.  The decision to purchase with low or no cash-flow is something I dealt with recently when deciding to continue renting or purchase a property. What I came up with was figuring out which scenario was going to build me more wealth.  I used what I was paying for rent ($1500) as my baseline.  In other words, I analyzed the property using $1500 as the current rent for the property even though I knew the property I was purchasing would rent for 1600.  Then I built a couple simple excel tables to compare the numbers.  I suggest building your own so you understand what each cell means, but feel free to check out and play with my product here: Rent vs. Own.  I've changed the numbers around to help analyze your situation, but the variables could be off and need to be considered.  You'll have to do a little admin work if you want to look at an example where you stay for more than 2 years.  However, it looks like a ~8% cash on cash.  That's very respectable if the rest of the variables are the same.

4. Owner occupied is the only scenario where I think low cash flow is more reasonable. I would always prefer more cash flow. Period. That said, when you're house hacking, you can use the owner occupied products like FHA loans to get in the property for low money down. I don't want to live in a C type multifamily. I've moved beyond that stage in my life. In fact, I probably will never live in a multifamily again. However, while you can make it work, you can probably get your foot in the door for some great properties by taking advantage of the owner occupied products!

The things I feel like you need to answer are:

1.) Make sure you're accounting for all the basics when you do the cash flow formula, which I think you're probably tracking based on your readings, I just can't see your work.

2.)Why is this an emerging market?  What indicators are you seeing?

I hope this helps.

Good luck out there!

Cheers,

-Sam

Scott,

The situation sounds like your relatives need to refinance or sell the house.  If the value actually is 160K they should have no problem selling or refinancing to improve their financial equation.

I think an appropriate follow up question would be: "why is it a problem house?"  If the rehab is the issue and they don't have the cash, the refinance will help.  If the refinance unbalances their financial equation, then selling the house and using the proceeds to purchase a new one is probably a viable answer.

Look into FHA options, or even VA if they happen to also be military.

Good luck.

-Sam