All Forum Posts by: Bob Galivan

Ari Hadar: Yes, but... it depends on the coverage of the MLS, and the particular market you are analyzing. The lower the rental price, the more likely the rental will be privately placed because the commissions offered take too big of a chunk out of the income. The overall trend for a metro area, even if the price range is offset from what you are exploring would be useful. If you the rental market is tight, it's hard to move because there isn't any place to move to. Economic conditions contribute - if the wage base of the population is under what homes are selling for, it also pushes more people into rentals.

Just about every ROI analysis I see includes a "vacancy rate" factor that is used to "adjust" gross annual income as an accurate representation of the rent that the investment can be expected to throw off each year. The common number seems to be 10%. If my property rents for $1,000 per month yielding a $12,000 gross, the projected income for the year would be the annual gross X vacancy rate = $10,800 that I can expect from my investment.

But what is vacancy rate, anyway? It’s common usage is to represent the time you expect your unit to be vacant in any given year. A 10% vacancy rate says that I expect my unit to be empty for 36.5 days per year, or just over 1 month (5.2 weeks). The other way to read it is that I expect it to take 5.2 weeks to refresh the unit, find a new tenant, place that tenant, and start collecting rent. Note that the costs associated with those activities are not represented in the vacancy rate, only the period I expect the unit to be non-productive.

In the initial review of a potential investment, your calculation must include factors such as:

• The typical time-to-rent in your market
• How long does it take you to refresh a unit assuming normal wear-and-tear
• How long does the average tenant say in the market AND in your units

Time to rent: If you are a high demand market, you may have tenants ready to rent with no delay. If you’re in a low-demand or seasonal market, you may have the potential for months of vacancy. For example, in the Cleveland market, properties near the Cleveland Clinic have their “hot” period from January thru March with occupancy in May and June. The target market is medical residents and students coming to intern at the clinic. Units available outside that range can remain vacant for 3-5 months. On the plus side, most of these tenants stay for 2-3 years.

It's important to know what the inventory of units is in your market, and what the absorption rate is. This is an area where access to the MLS is important. We divide the number of closed rentals in a month by the number of listings that were available. If there were 5 rentals out of 10 listings, that's a 2-month inventory of units. 2 rentals out of 10 listings is a 5 month supply. A stable market is between 4-6 months of inventory, but that is subjective and really dependent on your market. The takeaway here is the tighter the inventory, the faster units will rent and usually at higher prices.

Time to refresh: The time to refresh depends on two factors: the quality of the crew doing the refresh, and the quality of the tenant in the unit. During the term of tenancy, one of the critical things a landlord must do is keep an eye on the condition of the unit. If maintenance visits show that the tenant is not properly caring for the unit, steps must be taken to put the tenant on notice of that deficiency if it will lead to higher repair times or costs. Your lease should include some provision to this end. If the tenant leaves the unit in poor condition, the time to refresh and the cost will be substantially higher.

Tenant Stay: Tenant stay is an important bit of information. If you are working in the subsidized housing market, HUD estimates that the average family remains in a home for 3 years. If you have access to the MLS for your market, you can look at historical rental listings. MLS data goes back several years, so it's possible to see how long ago a particular unit rented. If you look at rentals 3 years ago, you can see at what point they went back on the market. If the average turn in a particular market is 3 years – if the properties come back on the market in that cycle, that's an average 3-year tenancy. Obviously, this is a rough measure, but it's data that is important to have.

So what does all this mean?

1. Vacancy rate is a highly subjective value that may present a less-than-accurate factor when calculating ROI.
2. It’s very important to be accurate with vacancy rate when analyzing a purchase; you can fudge the numbers by estimating high, but too high or too low presents an inaccurate picture of the investment. Doing a little homework on the market, especially if you have experience will go a long way.
3. Never adjust the vacancy rate to force the numbers into compliance with expectations! If you're shooting for a 10% ROI and a market area vacancy rate of 12% lowers the ROI, adjusting the vacancy rate outside of parameters is going to come back to bite you.

Track your vacancy rate! As you grow your portfolio, the combination of your market, your tenant selection policy, and your management skills will have an impact on that number.

@Federico Gutierrez: Not sure if I understand. Are you saying that a buyer would be better off spending the time and money to get a license in order to purchase a short sale? Wasn't clear.

I do disagree with the last statement: "... no ordinary buyer agent will work this for an investor for the very little commission offered by the bank/listing agent." I would certainly work any short sale or any other sale for my buyers. It's my job. I am and have always been "commission blind" as our code of ethics requires us to be. I have worked my *** off for little money in the past, but it has almost always paid big dividends in the form of future business, referrals, and testimonies as to my commitment. In my opinion, a short sale does not take much more work than any other sale on the part of the buyer's agent. And, in my experience, the bank/lender will usually pay a reasonable commission for the work. If they do not, I can sometimes recover some from my buyer, but if I cannot, then I do as good a job for a 1% commission as I would for a 6% commission.

A client recently contacted me about a short sale in the Cleveland market that seemed to be priced way below market value. After digging into the listing info, I found a fairly typical approach to marketing these properties, which rarely benefits a buyer.

As you know, short sales occur when more is owed on the mortgage than the property is worth. The owner cannot make the payments, or from an economic perspective, sees that it makes no sense to continue making the payments. I won't discuss the ethical aspects of that particular decision, but it happens.

The concise version of a short sale is: The owner stops paying the mortgage; the property is listed for sale in the MLS; offers are solicited, and one is submitted to the lender; the lender requests info on the owner's financial situation to determine if the ability to pay exists; the bank obtains an appraisal of the property to see if the market value is in line with the offer; The bank loses the paperwork at least once, causing the process to restart; the bank may counter the offer, but at some point, a deal is reached, and the sale proceeds; the owner cannot receive cash at closing in any way, for any reason. Title transfers, and the deal is done.

So, where does a short sale go off the rails?

• The property is listed far below market value to drive offers, hoping that the potential buyer will meet the bank's counter-offer. It also acts as a lead generator to bring in potential buyers.
  
• A variation on the lowball listing price is the "auction" process. A property is supposedly put up for "auction" to the highest bidder; since it's a short sale, it's simply a way to solicit more offers and find new customers. It used to be that banks would set their bottom-line pricing (essentially pre-approving a short sale), but that practice rarely happens.
• The short sale takes forever to complete. I have managed short sales that took more than a year to get to closing, and I have managed short sales that were all done in 3-4 months. The process depends on a myriad of factors coming together in a strict timeline. The year-long sales usually occurred because the bank lost the paperwork or the buyer was borrowing to buy, and the property didn't appraise, requiring it to be re-listed.
  
• Obscene fees are charged by the listing agent or the short sale negotiator. When short sales were in high volume, it was typical for a title company to have a negotiating person who handled the bank's communication for a small additional fee. Sometimes attorneys got involved for a somewhat higher fee, but overall, I think the general cost of short sales was $500-$1,200 depending on the length of time they ran. Unfortunately, various players realized that there was money being left on the table, and the fees started going up - way up. I recently saw a short sale that required the buyer to pay a non-refundable deposit when the seller accepted the offer, plus a $3,000 "short sale fee" at closing. Since most short sale negotiations happen online through various portals and require very little in the way of time, there is no basis for the excessive fees I see being charged to buyers.
  
• Even my complex short sales (when I was actively doing them) took maybe a max of 8-10 extra hours over the normal listing agent business, so I was fine just providing the service. Since title insurance is so profitable for the title companies, it made sense to offer the service with a modest fee structure to get the business in the door. 

For any buyer, one of the risks of a short sale is the lack of incentive for the owner to maintain the property beyond subsistence levels. If a tenant is in the property, that can be a problem because the owner will still collect rent without providing any but basic services. The result is the investor inherits a hostile tenant or a property that needs excessive repairs. Since the short sale property is probably occupied, it's difficult to deep-dive into potential repair and maintenance issues.

The optimal way for a realtor to handle a short sale is to list it at a price that's in the ballpark of where the property will appraise so that it's more likely the bank will accept the offer. For the investor, doing as thorough inspections as possible to document costly repair issues afford the chance to negotiate a reduction with the bank because of those problems. If the property starts below market, forcing the bank to expend resources to negotiate the price up, they will be less likely to turn around and let the price fall. As with any investment purchase, understanding all the underlying risks is key to becoming a viable property.

Last word: We use the term "bank" as the target of the short sale negotiation, but in reality, there is rarely a "bank" on the other end. The initial contact for short sale negotiations is either a third party hired to handle the interaction or the entity that is servicing the loan. In fact, the original loan was sold off the day after the purchase closed and was probably sold multiple times thereafter, so the entity that actually owns the note is a construct - a trust or a fund or Santa Clause with no human face. I have conducted negotiations with third-party companies acting on behalf of the servicer, operating based on the noteholder's redemption parameters. It would take weeks for answers to questions to come back because the communication process was so convoluted, plus it was common to have the person who initially engaged in the negotiations on behalf of the lender leave the company or transfer out, so you'd end up with a new person, new approach, new hostility, etc. Frustrating.

Bottom line: Don't dismiss short sales as a way to acquire income property, but don't make them your primary focus. They should be an ancillary part of your strategy, not the main focus.

@Andrew Weiner: One of the key tasks in purchasing a property are the inspections. It is true that many properties here that look to be a bargain are in fact bulldozer-ready, but quite a few are salvageable. Where many inexperienced investors fail is in assuming that because the property is cheap, bringing it up to rent-able standards justifies cost over market value. However, if market value can mean two things: what the property would appraise for based on area comps, and the return the property would deliver once rented. I also work in the Miami, Florida market and I can tell you that the inspection process there far exceeds what is offered here. In Miami, the inspections are not only more thorough, but the inspectors also provide repair estimates for identified items. It goes a long way towards helping determine the ultimate worth of a property. 

Over the past three years, I have been imbibing information about the Cleveland residential income market, both as an active investor and a Realtor with clients interested in investing. My focus has narrowed to affordable housing in part because it delivers consistent, somewhat guaranteed returns, but also because there is a need for better quality housing in that space. Due to the financial crisis, the borderline
unscrupulous (and often illegal) promotion of Cleveland investing to foreign markets (low money in, no improvements, exit by abandonment), and the market-killing point-of-sale inspections, it's a market that cries out for even a moderate level of social responsibility to breathe life back into communities.

I thought I would share some of my criteria/analysis on investing in this market; it is information that I provide to potential investors and pretty much what I use to look at investable properties for them and myself. These are all my opinion, obviously not intended to be legal, financial, or other investing advice. In no particular order:

• Never analyze a rental property's potential ROI by adjusting the gross rent to "make" an attractive number. There are numerous websites with rental market data (like Rentometer) that provide a "spread" of values. I use the lower and average values for my numbers. If the ROI is within your target range, then it's an indication, it might be a viable investment. If you have to "bump" the income up for it to make sense, you're going to lose.
  
• In-depth inspections are critical. You could buy a property for a penny, then find that you have to put more money in than you can ever recover. A key inspection to make is having the drainage (storm and sewer) lines camera inspected. It's a $450 or so inspection that can save you $10,000 in repair costs. Lead-based paint is a fact of life, as is asbestos wraps on radiator pipes.
  
• The City of Cleveland passed an ordinance requiring all rental property to get a lead-based paint inspection and clearance certification starting in March of 2021. It's a rolling program over about 18 months. The base cost for inspections will be $250-$400 per unit, so factor that in. Mitigation can run as high as $5,000 per property. It is critical that you factor in dealing with LBP right after you close so that you can pass the inspection.
• Water and sewer costs here are high; I use $35 per bedroom with a minimum of $80 per month. You cannot submeter unless the tenant has free access to the meter, and you cannot apportion the water bill.
  
• The minimum cost for liability insurance is around $800 for an SFR. You can find cheaper coverage that will not protect you. Companies are getting very picky about homes with old roofs or with knob-and-tube wiring. They will ask what percentage of the house is KnT. If it's more than their minimum, the insurance cost will be significantly higher. If you misrepresent the percentage and something happens, you lose. If the home has significant KnT, consider factoring replacement into your costs, even if you spread it out between tenants.
• Purchase Worker's Compensation Coverage for each entity that owns a property. It costs $120 per year if you have no employees. If a worker is injured and it is determined they fall under the employee category, not having worker's comp will cost you thousands of dollars in penalties and claim matches.
  
• Use a vacancy percentage - 10% is typical - as an adjustment for lost rent. If the unit is vacant for a month, you don't collect for that month, so you have to account for that loss. However, most people do not include the cost of turning over the unit - cleaning, painting, etc., as an ongoing expense. If your tenant lasts 2 years, the cost to rehab a unit will be at least $1,500.
  
• Standardize everything - if you will own multiple units, standardize paint colors, flooring types, etc. You can bulk purchase if appropriate and so that you can quickly match/repair problems. I avoid carpet like the plague and use either sheet vinyl or vinyl plank flooring - after two tenants, it pays for itself. Be sure to purchase extra materials, as the manufacturers discontinue colors all the time.
  
• If you are buying a turnkey property, aside from inspecting with a microscope, assume double the maintenance percentage the first year - turnkey properties are not going to be paragons of quality rehab, and the hidden problems will kill your ROI.

All the time for now, but I'll be back. 

Hi, Kishun. Welcome to the forum. As you see from the responses below, there are differing opinions as to whether or not to use cash for your purchase. My thoughts are as follows:

• First: A "Duplex" in Cleveland refers to a property where each side of the duplex can be sold as a single family home. What most people think of as a duplex here is called a two-family, which has two living units that would be sold as a single property or rented as two units.
  
• In most cases, traditional lenders will not lend below $50,000.00. Given the broad range of pricing in the Cleveland market, that's a consideration. At $50k and up, its usually 25% - 30% down. The income of the property can apply to the income requirement for the loan (depending on the lender). If you purchase a fixer-upper cash, once there is a tenant in place, you can refinance and pull cash out - use leverage to get most of your cash back.
  
• There are multi-family properties in this market that can be had for very little money, but need substantial repair. Right now, there are 191 multi-family properties (two-, three-, and four-family) available in the City of Cleveland and East Cleveland priced from $13,500 to $549,000 with a median price of $79,900 - that means that close to 100 multi-family properties in that market can be had for under $80k
• In the past 90 days, 265 mult-family properties sold from $7,000 up to $395,000, with half selling below $85k. So it's a healthy market.
  
• One thing you need to watch out for are municipalities like Shaker Heights that require Point of Sale (PoS) inspections.I am not 100% sure, but I think that mosts of the municipalities require that the seller obtain the inspection and provide it to the buyer BEFORE going to contract on the home. It is (unfortunately) common to see the seller require that the buyer obtain the PoS, or that a buyer goes to contract before the PoS is issues. The problem is that if the seller does not fix the issues noted in the PoS, they become the buyer's responsibility. On top of that, many municipalities require that the buyer willing to assume the PoS violations put money in escrow equal to the amount the city thinks it will cost to repair the problems. Shaker Heights requires 150%. If Cleveland Heights decides that the repairs will cost $8,000 to fix, you have to put that money up at closing and leave it there until you fix the issues and pass inspection. It can double the cost of repairs. Cleveland does not have a PoS requirement, so most of my focus in that city. East Cleveland has a PoS Requirement but doesn't require escrow. There have been some lawsuits where courts have found that PoS inspectons are unconstitutional, but the finding applies only to specific municipalities. There are some attorneys that are trying to get this opinion registered on a state-wide basis, but it's not happened yet.

Not sure what about that post is special. First, the idea of grading neighborhoods (as another post pointed out) is akin to redlining neighborhoods. Someone not from Cleveland is going to look at the infamous map and decide that the D and F areas are out of bounds - who would invest in a low income area? The very idea!!!

ROI is the holy grail of investing. If you can get 15% ROI in a supposed "F" neighborood compared to 8% in a supposed "B" neighborhood, which one are you going to pick? Cleveland has an image problem in part due to that map. Over the past month or so, I've looked at three porfolios and two multi-family buildings, all in D and F neighborhoods that, following rehab - would yeld more than 10% ROI.

One of the problems that exists in Cleveland is the presence of absentee owners who are focused solely on ROI. I "attended" an online presentation targeted at French investors that promised 16% gross returns, and presented pictures of some properties plucked from Zillow. One property manager I work with had some experience with these "investments" a couple years ago. He exited that relationship after getting bombarded with calls from foriegn investors demanding their money - they netted less than 5% after the expenses, commissions, and other fees were extracted. I have another friend who works with several tenant advocacy groups who deals with this stuff all the time. Out of town investors purchase properties through local "brokers" and extract every penny of revenue without further investment in the property, then exit the market by abandoning the property to the city.

Focusing first on ROI, then on the area where the property exists with the idea of even a modicum of improvement to the home - and thus to the neighborhood - is a solid investment strategy, in my book. it's what we are pursuing. Investing in a community without some desire to improve that community is not a very worthy strategy, IMHO.

Ms. Martin: Some thoughts...

If you're going to be an absentee investor, the main focus of your trip should be to find a trusted advisor, more than trying to learn the market. As another poster mentioned, there is a vast array of investment possibilities here, which can be separated into levels of risk and levels of return. Generally speaking, the worse the condition of the property, the higher the cost of rehab, but the higher the potential of return. These properties carry a higher risk in terms of cost, but a much higher return potential. The advantage is that you control the entire rehab process, including providing for future mainteance. The choices made during rehab can come back to haunt. The other end of the spectrum are turnkey properties, where the property is rehabbed, often with a tenant in place. The risk is lower in terms of cost - you're paying a fixed price and you have an idea of return, but you dont know the quality of the work, and you don't know the quality of the tenant.

The investors that I work with generally provide guidance as to what they want to achieve for returns but stay pretty much out of the overall process. It's a better relationship if you are not going to be hands-on with management. If you structure your acquisitions properly, you can either be a sole investor or you can be part of a small group of investors getting into multiple properties together, with shared returns. It lowers the indivdual risk somewhat, and usuall yields higher returns because you increase your purchasing power.

Also be aware that Ohio law requires that property managers must be licensed, and must be affiliated with a real estate broker. There are firms that will offer to manage your property, but you need to make sure that there is a licensed Ohio broker involved. This is a protection for you. 

Mr. Wilk: In no particular order:
a). Two key factors when evaluating potential returns: the property taxes in the municipality and the Point of Sale requirements. Cleveland (the city) is generally has the lowest property taxes and has no point of sale requirement. Shaker Heights has high taxes, and the PoS requirement is an escrow of 150% of the estimated costs to repair. Most of what I look at for investing is in Clevland proper.

b). You have to decide where in the market you want to be in terms of tenancy: low income, moderate, or high. The better returns are in the low income space; the investment is much lower, with rents ranging from $500-$1000 per month. The more expensive the property, the lower the ROI.

c). I separate properties into three categories:Raw state, moderate repair, turnkey. Raw state are properties that are in need of major rehab. You can buy these for almost nothing (sometimes for nothing), but you will have to invest in rehabbing them. Moderate repair are those properties that require mostly cosmetic attention, and turnkey are ready-to-go. The advantage to raw state properties is that you have control over the rehab process, so you can factor in future maintenance - instead of carpet, you can use vinyl flooring, for example, or deal with lead mitigation upfront. Raw state properties have the highest risk, but offer the highest returns if you can control costs. The other side of that are turnkey: there, you are buying a rehabbed property, sometimes with tenant in place. You have no knowledge of the quality of the repairs, nor do you have any say in the tenant in place.

d). Inspect, inspect, inspect. The disaster areas (so to speak) are the places you cannot see. If you are buying a raw state property, you might assume that since you're going to rehab the whole thing inspections are not necessary. Nay nay! Camera the sewer/drain lines. Run a house around the perimeter of the house. Bring your contractor in during inspections to give estimates. You need to account for every potential expense before you buy. For turnkey properties, its even more important - camera the lines, because the rehab probably didnt bother with them. have the contractor check the property for quality of repair.

e). Be aware of the Cleveland Lead safe initative! Starting in March 2021, all pre-1978 properties in cleveland have to pass a lead inspection. If you are buying to rehab, you can address this, but if you are buying turnkey, be aware of this ordinance.