All Forum Posts by: Troy Zsofka

@JR T.

This is interesting because I have just spent the last couple hours researching whether or not to self-insure our portfolio. (Of course, as discussed in this thread, I would keep substantial liability coverage).

What I found is that the statistical value of the property insurance, based on Claim Frequency (percentage of households making a claim each year) and Claim Severity (average payout for each claim), in the categories of Fire & Lightning, Wind & Hail, Water Damage & Freezing, and "All Other Property Damage" pales in comparison to the premiums charged. Furthermore, I found that, with the exception of Fire & Lightning, the average claim is less than the $10K deductible I carry on most of our properties, which suggests that I am getting extremely little statistical return on those premiums. 

My conclusion is that I am either going to lower my deductibles so that I actually get some statistical return, or I am going to drop the insurance altogether (again, except for a nice hefty umbrella liability policy).

Here's the stats: http://www.iii.org/fact-statistic/homeowners-and-r...

Disclaimer - as far as I know this is for single family residences only. Not sure.

What I did was to create a spreadsheet whereby I extended the claim frequency by the number of properties (to figure out what the probability is of having any claim in a given year). I then applied this percentage to the average payout for each category after subtracting varying deductibles, for a comparative analysis looking at a few different deductible levels. Sum up all categories, and you have the statistically expected payout for each deductible level. Unfortunately, the analysis is flawed because I don't have data for claim frequency above each deductible amount, and average payout of those claims. However, it's close enough to see some interesting things. Most notably, the analysis is sound with a $0 deductible, and the statistical value at $0 deductible still doesn't even outweigh the premiums at a $10K deductible. I have an email into my agent to get estimated premiums at varying deductible levels so I can plug in the numbers and compare apples to apples.

My conclusion: What we all knew already anyway, which is that insurance premiums have to be more than the actual value of the coverage because they have to include operating expenses and profits for the carriers. My analysis just really hit it home. I strongly believe that insurance should only be used to protect oneself from a loss that one can not sustain (meaning that if you can absorb a potential loss, don't insure against it because it is statistically, and in all probability, a losing proposition). This leaves liability insurance and catastrophic healthcare coverage as the only policies that seem to make any fiscal sense in our case.

Now I just have to decide whether the difference between the policy premiums and the statistically expected payout is a price I'm willing to pay for the peace of mind, or if I'll do what I know makes most financial sense and just self-insure.

"Debt Service" is your mortgage payment (typically annualized), not including any escrow. So it's the annual amount of Principal and Interest that you pay according to your loan terms.

Debt Service Coverage Ratio is an analysis of how well the property can service its debt. The numerator is NOI (Net Operating Income), and the denominator is Debt Service.

Quick numbers: If your NOI is $125K per year, and your Debt Service is $100K per year, your DSCR is 1.25x.

Why not play it conservative and take out an amount that leaves you a nice high DSCR and low LTV? Extended vacancies are a real consideration, especially in commercial. Everyone wants to get big fast, but if it's owned F&C right now, don't put yourself in a situation where it could all come crashing down if you have a tough spell.

Not looking to lecture, and I don't know your finances, but the turtle won the race because the hare got flattened by a freight train at the intersection of routes 2006 and 2007 because his speed was too close to 100 mph (read LTV)...

@Jay P.

Your debt service coverage ratio actually does not improve. DSCR is a measure of the property's ability to cover its debt service payments.

NOI/Payment, not (NOI+(Other non-related income))/Payment.

There are only 2 ways to improve DSCR:

1) Increase the numerator (NOI) either by increasing income (of the property specifically) or by decreasing expenses (tax abatement, lower insurance premium, restructuring leases to put more expenses on tenants, etc). Even lowering your vacancy rate will not likely accomplish this because NOI, for the purposes of DSCR analysis anyway, will likely use an automatic value for vacancy rate.

2) Decrease the denominator (debt service) by getting a lower interest rate, extending the amortization term, etc.

It's important to remember that a lender will not want to rely on your desire to inject other funds into the property in order to keep it afloat, regardless of how much money you make, unless you sweeten the deal somehow (maybe a collateral position in another property like a second lien on your primary res or something). If you are willing to do that, you will want to look for a local portfolio lender to structure that sort of cross-collateralization; a conventional lender won't do it. 

If this is a purchase, the bigger question is, why do you want to own a property that doesn't cash flow? If the DSCR doesn't work, then either the price is too high, or you're trying to leverage too much of the value (which the lender won't allow anyway).

If this is a refi and you're trying to access equity for other purposes (like more investments), be careful, you're heading down a slippery slope.

Hope this makes sense,

Troy

@Kyle Gregg

Not sure where you extracted that quote, but if it certainly does imply some potential responsibility of the mortgagee, just not to you. A few thinks to consider:

1) The verbiage in that excerpt really aims to protect the insurance provider, not the mortgagor ("A mortgagee’s failure to do so will defeat coverage under the policy", and "The mortgagee must then notify the insurer or risk a loss of coverage in the event of a loss"). The consequences of failing to notify the insurer of a change are cancellation of coverage, not liability in the event of a loss. Furthermore, nowhere does it say that the mortgagee is responsible to arrange for the correct insurance to be put into place.

2) Even if you are right, and the mortgagee is somehow responsible for your losses (which I doubt), it's likely going to cost you much more than $5K to fight this thing in court.

So, while the excerpt you quoted certainly suggests that the mortgagee may have had a responsibility in this instance to which they did not live up, those responsibilities seem intended to protect the interests of the insurer, and this does not, in my opinion, hold them responsible for your losses. 

I think that perhaps your loan officer gave you substandard service by not following up with you each step of the way in an advisory role, but I don't think that makes them responsible for the consequences. Maybe an attorney would feel otherwise.

Unfortunately, I think you just learned a $5K lesson that you will not soon forget.

Like @Kelly Edwards said, the property must cover its own debt service (and then some) for a commercial lender to consider it a sufficient collateral asset. That said, if it's 4 units or less (not considered commercial from a lending perspective), your W-2 income can make up the difference if the DTI (Debt-to-Income Ratio) works. They'll typically wash the PITI with a percentage of rental income and then put the shortage to your monthly debt total. Or an underwriter may use EBITDA to determine the cash flow shortage and then likewise put it to the numerator of your DTI.

However, I doubt a commercial lender (5+ units or non-residential / mixed use) is going to lend on an asset that doesn't have a DSCR that meets their guidelines (1.15x minimum I suspect, but typically 1.25x). That's conventional anyway, and it's been a few years since I was in the commercial lending field so guidelines may have changed...

Wow, sounds like there is quite a co-mingling of insurance providers' interests and local/state government's ability to enforce standards and levy fines. Goes back to the general good policy of not trying to get away with nickel-and-dime antics.

We've always believed that you're better off complying with rules and regs, and running your business above board in general. Real money is made by what you produce, rather than shortcutting the system. 

Thanks again for everyone's input on this subject.

Thanks for your input @Charles Socci, I think it's very good advice for a lot of new investors thinking about trying to cut costs. 

I carry the appropriate worker's comp, property-specific builder's risk insurance, and an umbrella liability policy that covers all activities at all properties. No contractor licensing required in NH, but I do carry the RRP (lead paint) as required by EPA for rehabbing pre-1978 dwellings. I also sub out the plumbing and electrical if the scope of work is such that a permit is required. I'm NORA certified to work on oil-fired heating systems, but that's not a licensing requirement either, just helps to know what you're doing if you want to tackle a no-heat call yourself. So in our case, all of those bases are covered appropriately. 

We've been at it for quite some time, so while I'm not sure it's any faster than subbing it out would be, the quality is the same (which is extremely important with a long-term hold strategy), and our mentality has been that it's gotta be less expensive. 

One thing you mentioned about which I'm not entirely sure: "hefty fines" for carrying the incorrect worker's comp? Worker's comp is private insurance, not government run like unemployment insurance. So if your insurance carrier feels that you are not carrying the correct classification for your employees, they could force you to switch or drop you, but they have no authority to impose fines. Not sure, I could be wrong on that, but I feel that the most they could do is back-charge you for the entire most recent policy period, and only if they allowed you to stay on with the correct classification and you chose to accept rather than go elsewhere for your policy.

Thanks again for your thoughts.

I've noticed from reading posts and listening to the podcast that a lot of investors these days seem to be using contractors for their rehabs. 

I understand that high-volume fix and flip investors might be better off delegating certain things (such as the rehab) and focusing on finding and closing more deals, so it makes sense to sub out the renovation work. However, we've been at this for some time and have always used full-time W-2 employees for the renovations. Our volume isn't incredibly high because we hold basically all of our projects long-term as rentals, and we have repairs and maintenance on our portfolio to concern ourselves with (another reason why full-time employees have always seemed to make sense financially). I am currently having difficulty finding good full-time employees to hire, so I've become curious as to why so many investors go with contractors rather than employees. Perhaps I might consider going with just 1 full-time employee to handle repair issues and then sub out more of the renovations on new acquisitions. The full-time employee could always work on the latest acquisition doing demo and removal etc. to prep it for the subs when not busy with repairs.

Running out of work and having an employee collect unemployment is not really a concern for us. I always buy a house or two ahead, and even if we were to run out of new projects for a while, there are plenty of houses in the portfolio that could use improvements that we had put off at acquisition in order to get to the next one more quickly (for example: new siding or exterior trim replacement that wouldn't change the rental value but needs to be done prior to selling, a roof that will need replacing in the immediate future anyway, etc). We also own multiple lots that could be taken out of current use and developed if we ran out of projects. So, providing consistent work to full-time employees is not a concern.

Any feedback from those who have tried out both avenues would be appreciated. Maintaining the strategy that has worked for us so well this far seems to be the obvious choice, but I'm always open to other opinions that might change my mind.

Stick with it @Dylan Wells, you'll get there. Slow and steady wins the race. 

One key is to put the flipping profits into the next acquisition, and not into shiny new objects. Also make sure to set some of the profits aside for Uncle Sam - short-term capital gains are painful.

Careful with the older homes for long-term holdings because they tend to have higher R&M costs than newer ones, and they tend to cost more to heat which can drive tenants out.

Enjoy

Hi @Seth Carlone-Hanson,

Dublin is a nice town right outside of Peterborough which has some decent restaurants and strong RE values. Good live music at Harlow's too.

I do a mix of in-town and country, but I'm picky about the in-town neighborhoods because I don't have much difficulty with rent collection and I'd like to keep it that way.

I see plenty of rehabs each year, it's just a matter of finding the ones where the numbers work as long-term rentals. Right now I don't need many to keep my appetite full because I am strictly buy and hold, but if I were to see more good opportunities I'd probably flip a few to replenish my capital in order to build my rental portfolio more quickly, rather than turn down a good deal.

Thanks to everyone for their responses.