All Forum Posts by: William Whitley

Good evening, Karl,

I would recommend looking at more than one data metric. Cap rates can certainly provide insight, but the challenge is ensuring that cap rates extracted from comparable properties are treating expenses similar to that of a property one is comparing them to. One example is some cap rates may include replacement reserves as an expense, while others may not have any replacement reserves in the cap rate. Using a cap rate that includes reserves and applying it to a property that does not include reserves can give an inaccurate indicator of value. That is just one example of why caution is necessary when using cap rates to evaluate a property.

If buying a property to hold as a long term rental, you also want to look at how many available units are currently on the market, and estimate the market absorption rate to determine how many months of inventory are available. The property someone is purchasing for long term rental will be competing with these other properties, and the property may or may not capture its market share. Furthermore, if there is more supply of units than demand, that is going to result in downward pressure to rental rates, whereas if there is a shortage of supply with potentially pent up demand, that is going to result in upward pressure on rental rates.

There are many factors to consider when evaluating a potential investment property purchase, and it’s important to analyze available data to make an informed decision without crossing the line into analysis paralysis. 

Bill 

Good evening, Patrick,

My standard answer to most questions is “it depends”, and that is applicable here. It depends on the age of the property, the condition of the property at the time of purchase, the age of the major systems, the age of the roof, etc. It’s important to have a replacement reserves account that anticipates the remaining economic life of various components that will need to be replaced in the future, and forecasts what those anticipated costs will be. Then you can calculate how much money will need to be set aside on a periodic basis to be able to cover those costs when the time comes. 

If you can place those replacement reserves in some type of investment account, the interest earned over time can help leverage your investment for replacement reserves.

Appraisers will sometimes use a sinking fund factor, which is a formula used to determine the amount that needs to be deposited into a sinking fund at regular intervals in order to accumulate a specific future amount for future capital expenditures. 

Some investors may use a rule of thumb like say 15% of monthly income. The problem with using a rule of thumb is you may find that you are still short on the funds you need when the time for replacement of these CapEx items comes.

I hope that is helpful.

Bill 

Good afternoon, Lynnette,

This is a risk/reward scenario. The question is what could possibly go wrong? I don't mean that as sarcastic, but as a thought provoking question. Even if the insurance rates are high, what would happen if the property were to be destroyed? Where would that leave you? What if a tenant or other person were injured on the property and they sued you? Are these and other potential risks worth the liability of a claim absent insurance? I would not want to bear that liability regardless of what the savings would be by forgoing insurance. 

All the best!

Bill Whitley, CCIM

When you ask how do you run comps for a multi family home, I’m not sure if you are asking for data sources or about methodology. If you have a reliable data source, then you are simply looking for similar sales that sold recently. Preferably you want a similar number of units in the sales as your client’s property, and you want those units to be similar in number of bedrooms per unit and unit size. You also want the properties to be located in the same market area as your client’s property. You can also look for active listings that are currently offered for sale. If you can find comps, you can determine the price per unit, price per bedroom, and price per SF of these sales, and see which one seems to be the most reliable indicator. Then apply that to your client’s property. 

There are factors like Gross Rent Multipliers, which can be extracted out of the market from recently sold comparable properties by dividing the sale price by monthly gross rent. For example, a property sells for $1,000,000 and the gross monthly rent is $10,000. In that situation, the GRM is 100. Assuming your client's property is similar in that example, you could take their gross monthly rent and multiply it by 100. Let's say your client's property gas gross monthly rent of $9,700. The indicated value in that example would be $970,000. Of course you would want more that one sale that you could extract GRMs from. That's one example.

A more complex method is using cap rates to apply to net income, but that’s more involved, because you need P&Ls from the sales and the property rents and expenses need to be relatively similar to extract reliable cap rates.

I hope this helps. 

Good evening, Kaushik,

While I understand what you are trying to do and why you want to do it (it is a good idea by the way to put these properties in an LLC), Rocket Mortgage is probably of the mindset that you are already personally obligated to the mortgages, and until such time as your LLC is formed and active, there's no reason for them to move forward. Why? Because they have an approval process to go through, and until there is an active LLC, to them it's premature to start an approval process for an LLC that doesn't exist yet.

I realize it would be better for you to have them approve it before you proceed with the LLC formation, but they are looking at it from the vantage point of what is best for them. It's likely SOP for them. Even if they approve your request, subsequent to your filing with them post LLC creation, they may still require you to personally guarantee the mortgage liability even if they place it in the name of the LLC.

It’s good that you have consulted with your attorney, because the actions you are trying to take, while advisable by all means could potentially trigger the acceleration clause in your deed of trust.

I know many investors just starting out will buy a property in their personal name instead of forming an LLC, but later on decide they want to do what you are doing in forming an LLC and transfer the properties and mortgage underneath the LLC

Hindsight is always 20/20, but it is better to purchase property in an LLC then to try to move it after the purchase, particularly when there is a mortgage for the original purchase involved.

Good evening, Tony,

It seems a little strange to me that your monthly rent is being increased nearly 100%. That seems like an excessive increase unless you were paying well below market rent.

If I understand your numbers, your current expenses inclusive of rent are $50K, and it will go up to $74K with the rent increase. Unless you are able to increase gross revenue, your net income will drop to $45K, down from $69K. That is definitely a significant drop, but to answer your question with a question, what are your alternatives? If you have a comparable property that is available, you will still incur moving costs and other associated costs

I’m curious if the landlord’s goal is to have you vacate or if they think because you don’t have other options, you’ll simply pay the increase. If you think the landlord is trying to take advantage of the situation by assuming you will pay the increase, perhaps call their bluff with a bluff of your own, and tell them you are not planning to renew your lease. If the landlord doesn’t have anybody waiting to rent the property, and they don’t have alternative plans that need you to vacate, perhaps they will negotiate with you. After all, a vacant property isn’t producing cash flow. Of course, if their goal is to have you vacate, then you are giving them what they want. 

It’s a difficult decision for you to make, but unless you can increase revenue to absorb the increase in rent, you have to decide if the decreased net income is worth the trouble. 

I wish you well in whatever decision you make. 

Good afternoon, Annie,

If the lease and/or state or local laws do not require you to be present during repair calls, just tell them you are unavailable to be at the property during the repairs. Could you potentially lose them as a tenant? Perhaps but not before the lease expires unless of course they break the lease. Otherwise, just tell them no, because you are not available, and remind them you are not required to be present during said repair calls. If they continue to push for it, simply remain firm, or tell them a lease amendment is necessary to charge them a $500 fee per repair call to compensate you for your time. See what happens.

Full disclosure, I can be a trouble maker, and sometimes it gets me into trouble. So take my comments with a grain of salt.

Good morning, Jon,

While I am familiar with the ins and outs of 1031 exchanges from an educational standpoint, I have not personally been involved with one. However, if done correctly according to all the guidelines and requirements, the advantage is that you defer taxes on capital gains and you also defer taxes on recapture of depreciation so long as you meet the timeline requirements, the similar property replacement requirements, the qualified intermediary requirements, and you personally are never in possession of the equity, hence the QI. There may be a few more requirements I’m not remembering. The important thing is both to know the exact process beforehand and get as much lined up as possible before launching the process. 

Something to consider, the depreciation recapture is usually deducted from the basis of the acquired property, since you are deferring taxes on that depreciation recapture. As such, however much accumulated depreciation you are transferring, that will typically reduce your basis on the acquired property so that when you ultimately sell that acquired property (assuming you don’t do another 1031 exchange), it would effectively increase your capital gains, though accumulated depreciation on the acquired property would be adjusted out of that. When you sell (not exchange) an investment property, you typically pay taxes on two things at different rates: recapture of accumulated depreciation and capital gains. 

The 1031 exchange process can be quite complex, and you need to make sure you do everything correctly including meeting all the timeline requirements to avoid having it disqualified. 

I hope that is helpful. 

Good morning, Tyren,

I once owned a duplex that I was allowed to get a HELOC on, and I was actually surprised, because usually you are not allowed to get a HELOC on rental property. That was way back in the late 1990s if I remember correctly.

So what you are finding out seems to be correct, which is it is rare to be able to get a HELOC on rental property. Perhaps you can get someone to provide a second mortgage on the property that is not a HELOC but a traditional second mortgage, but I'm not sure what is available for that type of loan on a rental property.

Good evening, Barret,

I’m located here in Middle Tennessee.

I would encourage you to consult with an attorney to determine which organizational structure would be the best option for you and your brother. 

An LLC in Tennessee may be a good option, if that is where you plan to begin investing. As far as the organizational structure, it seems that multi-member LLC may be the way to go based on what you have described, but I highly recommend consulting with an attorney who specializes in business formation.

It also may make sense for your brother to have his own LLC for the construction component of the flips, in which case, the LLC for flipping can engage his LLC for performing the renovations. That way you can keep these two functions separate. It's cleaner that way.

In addition to legal counsel, you may also want to explore with a tax advisor what the various tax implications are based on the options you have regarding organizational structure. That way, between legal counsel and tax advisory, you can make an informed decision.

I hope that helps.