Camera Sewer Scope Critical for Denver Realtors and Buyers

Old House Sewer Pipe Problems:  When Don Nichols visited our real estate office recently, I asked him about his Denver sewer line inspection company. Specifically I wanted to know how it relates Realtors who are buyer agents shopping for older houses in the central Denver area with aging sewer infrastructure.

Here is a recap of the questions answered in the short video below offering tips and advice to Realtors, real estate investors, home buyers and home owners about the importance of understanding sewer inspections and repair costs.

• Beware the Sewer Line Repair Salesman
• How much does it really cost to fix a broken sewer line?
• Question the repairs being suggested by plumbing companies
• What are the hard costs of sewer line plumbing repairs?
• Is the Denver city main verified or that a sink hole?
• #1 TIP? Make sure they are putting the camera down YOUR sewer line!

It’s so refreshing to meet people who are really good at what they do, and can explain technical and mysterious jargon in plain English.  Don offers a unique perspective when it comes to the costs and risks of sewer line problems: in addition to being in the plumbing business with his dad since childhood, he was a Remax real estate agent for more than 8 years.

I did some online research for common sewer repair questions related to real estate agents and home buyers.  I was surprised to read that in many parts of the country sewer repair inspections are rare and not recommended by Realtors to their buyer clients.  Sewer inspections seem to be more commonplace in Denver real estate transactions, but there was also a lot of misinformation, mostly by people who Don calls “plumbing repair salesman.”

Thanks to our Special Guest and PMRE Approved Vendor, Don Nichols

Don Nichols
Certified Sewer Inspection
Denver, Colorado
303-847-9805
http://www.certifiedsewerinspection.net/

My Interview with a Special Investigator

I was having a pretty normal day at the office, comping properties, checking on email etc.  Until a pleasant looking woman arrived unannounced just after lunch and handed me her card:  Special Investigator for the Denver District Attorney. Ouch.  She asked me if I had a few minutes?  What else could I say, but “c’mon in…”

I asked what it was about, and learned that a certain property that we purchased and then resold last year was under a fraud investigation.  A fraud, apparently, that is becoming more and more prevalent in today’s real estate market and investors need to be aware:  people selling property that does not belong to them.   She asked me to pull the file for the property and then asked for copies of several of the documents.   Lots of weird questions ensued:  Please describe the seller’s, height, weight, distinguishing features?  She then showed me some pictures.  What do you remember about the ex-wife?  Excuse me?  What ex-wife?  I remember the son and the mom from closing, that’s it.  And they did not look anything like the people in the pictures!

Interesting thing was that we DID receive a call to the office earlier in the year from a person who complained that someone had sold her house without her permission.  But she sounded kind of crazy and we get calls from weirdos a lot in this business, so none of us really thought much about it.  But remembering that call, all of a sudden I felt like I was starring on the TV show Law and Order, so I had to ask:  “Should I be calling my attorney?” She sweetly replied that is was not necessary at this point (right), and informed me she is “a cop, not an attorney.”  (whew?)

So the story goes, apparently the “seller’s” of this particular house may not have had the right to sell the property.  This was a mild case compared to the blatant fraud that is happening with other deals, according to the investigator.  In this instance the husband “allegedly” removed the ex-wife from the deed with a Quit Claim deed without her permission and then sold the property and kept all the proceeds.  In my head the question kept coming up:  Am I in any way responsible for this?

After a pretty long cop-like conversation, I’m pretty sure I convinced her that our office and business had nothing to do with the Quit Claim deed and alleged fraud.  Although she admitted there were some red flags.  The organized groups that commit this type of fraud use a team of investors and agents, have in-house notary and use small private title companies to close the transactions.  We have that in common with the criminals.  Thankfully, we do keep impeccable records of our transactions and we were able to provide all documents she requested.  And the dates confirmed that our affiliated people or companies were not involved with the forged signature on the deed.  She also made phone calls to the title company and all the employees who were involved in the transaction and all our “stories matched.”

The investigator suggested that we make some procedural changes to our buying system which I would like to pass them along to other investors:  Ask for and get a copy of the driver’s license of the person who is signing the purchase contract at the time of signing. Make sure the driver’s license matches the title work, and be watchful of strange title occurances (like Quit Claim deed, power of attorney, etc).  We have previously left this type of identity checking to the title closer and never paid much attention during escrow if the title work came back clean.  In all my years of investing, this has never happened to me before, and hopefull will never happen again based on the new procedure.  Investors, keep a sharp eye out for this type of fraud!

Historic Home Renovation and Remodeling Tips

Denver Square Before Remodel

In this series we will discuss the all aspects of buying and remodeling older homes for both investors and owner occupant buyers.  The focus will be houses of the inner city Denver, Colorado neighborhoods like Baker, Curtis Park, Park Hill, Jefferson Park, City Park, Highlands, Potter Highlands and others.   But the information is relevant to house enthusiasts in other cities and neighborhoods with housing stock built between 1890 and 1940 where there is a rich historical blend of architecture and culture.

Please join our team of professional investors, agents and contractors as we help you explore the general nature of construction for Victorian, turn-of-the-century, craftsman, and Tudor homes, as well as some of the less-common alternative styles, like International Modern, Mediterranean, etc.

Denver Square After Remodel

The series will include discussion of foundations, fireplaces, furnaces, roofs, floors, porches, and windows.  We will explore the costs and benefits of remodeling for both profit and historical preservation, which do no have to be mutually exclusive.

If you share an interest in these types of houses and projects, please  join our mailing list or subscribe via RSS.  We will send you in-depth articles to read and videos to watch showing our adventures in buying, remodeling, selling and enjoying old houses.  Feel free to leave comments if you have specific questions about design, architecture, costs or construction of these beautiful and eclectic homes.  Preserve history and live abundantly.

Read the next article in the Old House Remodeling Series:  Old House Foundation Problems

Dealer Margin, Fix and Flip Profit, and Income Valuation

One of the first lessons I teach new investors or distressed niche agents in our mastermind group lessons are the different financial models for purchasing investment property.  There are several types of real estate investors, and they use different criteria to estimate profits depending on the value add to any transaction.

For example, a dealer or wholesaler’s value add is finding a property with profit potential.  The work of marketing to motivated sellers, negotiating price and signing a contract with the sellers is a business in and of itself.  A rehabber’s value add is making repairs to a property.  And a landlord’s value add is operating a property for the long term.

Most purchase formula evaluations are based on the industry term “After Repaired Value” (ARV).  This is a final sale value of the property either to an owner occupant based on comparable sales, or to a landlord investor based on income generated.

Dealer Margin

Dealers and wholesalers look to purchase the property at a price that will have enough margin to sell to a rehabber or landlord and leave profit on the table for them. Here are two common formulas:

• ARV x 65% minus cost of repairs = purchase price (buyers market)
• ARV minus cost of repairs x 65% = purchase price (sellers market)

If you run the calculations above based on a $100,000 ARV and $20,000 repair cost you will notice the difference between the two models, one for buyers market and one for sellers market ($45,000 and $52,000 respectively).  A wholesaler who purchases properties at these values will be able to sell to a rehabber and earn a profit on the deal.  CAUTION: When determining ARV, be sure to use all the available comparables, not just the “good ones.”  In a market of falling prices, it is also wise to check the active properties currently available as well as those under contract so you can predict a lower ARV by the time the property is ready for sale.  Time of year is also important when determining ARV.  Experienced rehabbers always want to bring their inventory to market during the prime selling season and will reduce their acquisition price during certain times of the year to account for holding costs.

Fix and Flip Profit Margin

The next formula is common for rehabbers or fix and flip investors to use:

• ARV x 90% minus repair costs minus profit margin = purchase price.
  (profit margin is subjective to each investor, but is often the amount of repairs or 15% of the ARV, whichever is higher)

This formula considers 10% of the ARV as cost of sale (agent fees, title), cost of funds and holding costs (utilities, insurance).  NOTE: Novice rehabbers would be wise to use 15% instead of ten to build a larger contingency for construction overruns and time overruns.  Using the same house as above, the final “retail” sale price would be $100,000 with a net proceeds of $90,000 after soft costs.  The hard cost of repairs is $20,000 and the desired profit margin is $20,000.  The rehabber would need to purchase the property for $50,000 in order to make a profit of $20,000. Going back to the wholesaler, who in this example would have purchased the property for $45,000 and sold it to the rehabber for $50,000 and made a $5,000 profit.  (the sellers market number of $52,000 would mean a higher demand for fix and flip properties and a higher sale price to the rehabber).

Income Property Valuation

For the Landlord model, lets use the same house and prices above, but assume the sale will be valued on an income basis rather than a comparable sales basis.  The simplest method of determining whether or not to consider a property for rental is the “1% Rent Rule:” if the example property sale price is $100,000, than it should rent for $1000 per month to make it a good investment for the landlord.  That is obviously a rudimentary method, and does not consider many factors, but is a good starting point and suitable for this introductory article.  The more sophisticated formulas are as follows (in order of sophistication and accuracy of the formula), and will be addressed in a future posting.  Be sure to subscribe to our Weblog using RSS or or your email to receive the updates.

• Gross Rent Multiplier (GRM):  Value = Gross Income X GRM  (usually 7 to 10 depending on quality)
• Cash on Cash Return (CoCR):  Calculation of % return on downpayment including tax benefits
• Capitalization Rate (Cap Rate):  Value = Net Operating Income (NOI)/Cap Rate (6 to 10 depending on quality)
• Internal Rate of Return (IRR) -this is an advanced model and calculation not suitable for this article

There are many subtle nuances that come into play with regard to these types of investment property income, profit calculations and evaluations of income property.  This article is only intended to provide an introductory overview.  If you are interested in studying these models in depth and learning the business of real estate investments, please inquire about our Investment Property Master Mind mentoring and business building meetings.  The hands-on “experiential” learning environment will enable you to work on real estate deals in a supervised environment.

As the “apartment guy” in our real estate office,  I field a lot of questions about income properties from residential agents.  The most common question is “how do I value this building?”  The agents are all very accomplished at running values using comparable sales for single family houses, and even duplexes.  But when the valuation needs to be determined from income rather than sales comps, they ask for help and advice.   Obviously there are several objective and subjective factors that determine the value of income property – location, condition, stability, unit mix,  potential, etc.  But here’s the 2 minute “quick check method”  I teach them for running rough numbers to determine if a project is worth further research or investigation:

1. Multiply the number of units by the monthly rent (e.g. 4 units at $300/month each) = $1,200
2. Multiply by 12 to determine annual Gross Potential Income (total monthly rents x 12 months) = $14,400
3. Deduct from the GPI an estimated expense structure (I use 30% as an average, so $14,400 x .7) = $10,080 NOI
4. This number is the Net Operating Income (explanation below) Divide the NOI by the capitalization rate to get the building’s value (10,080/.08) = $126,000 is the value of the example building  “at a 8 Cap” rate.

Simple Cap Rate Calculation

That valuation should take you less than two minutes to calculate, but you should strive to learn and know the reasons behind the determination of certain inputs.  How and why I use 30% expense structure and 8 capitalization rate is subjective based on certain assumptions and factors about the building.  These numbers affect the value dramatically, so you must adjust them carefully and accordingly.  Here is further explanation of the concepts of NOI and capitalization rate.

The estimated expense structure of 30% in step 3 includes vacancy, taxes, insurance, management and repairs.  It does NOT include debt service for mortgage payments.   This is an average number, and is probably low for most buildings in any state of mismanagement.  Poorly run buildings with high vacancy rates, deferred maintenance, theft, vandalism, inefficient heating/cooling etc will have higher expense structures.  Conversely, a very well run and well kept building with utility bill backs and efficient management may run leaner than 30%.

The number determined by deducting expenses from gross income (in the example $10,080) is called the Net Operating Income, usually abbreviated as NOI.  Once you have the estimated NOI (or determined in fact with the buildings financial statements), you can determine the building’s value at different capitalization rates.  The concept of capitalization rate  based on NOI is usually the aspect of income valuation that residential agents struggle to understand.    Capitalization rate is a measure of the return of a building that does not factor in leverage (mortgage and debt service).  It would be the “return on investment” to an investor if the property was paid for in cash.  Since most investors use leverage, which affects the return tremendously, cap rate is a measurement by which to compare properties, but is rarely the actual “return on investment” to the client.

Cap rates that a building will trade for move up and down depending  on supply and demand, money markets, and other non-controllable factors.  But it is also subjective to buyer and seller in a transaction and the “quality of the investment” in the eyes of the buyer.  The higher the cap rate, the better the investment the property is for the buyer, but the lower the price is to the seller.  When talking cap rates, you must reverse your normal thinking.   Income investors want to BUY at high cap rates, but SELL at low cap rates (yes, buy high sell low!).  Cap rates on buildings can range from a low about 5 to a high of about 13 in “normal” market conditions, and as you will see the effect on the value or price is dramatic.  A well kept building with stable tenants and good management might sell at a “6 cap,”  and a run down building with dead beat tenants might sell at a 12 capitization rate.  Institutional buyers tend to purchase larger properties at lower cap rates, and independent buyers tend toward smaller properties and buy at higher capitalization rates.

Here is the reason the capitalization rate is so important to income investors.  Watch how much the value changes on our example property from a 6 cap value to a 10 cap valuation:

• $10,080/.06 =  $168,000  at 6 Cap
• $10,080/.07 =  $144,000  at 7 Cap
• $10,080/.08 =  $126,000  at 8 Cap
• $10,080/.09 =  $112,000  at 9 Cap
• $10,080/.10 =  $100,800  at 10 Cap

The opportunity you should be seeing here is twofold.  As an income property investor, if you were to find a seller willing to sell at a 10 cap on existing income and find a buyer willing to pay a 6 cap on existing income, you would have a price spread $67,200!   Now that is a flip, and you didn’t even do any remodeling!  The other method of increasing value of an income property is to improve the NOI.   Suppose you purchased the above building at a 7 cap rate for $144,000.  Over the course of a year, you were able to raise rents on the building by $100 per unit to $400 per month.  You were also able to implement a utility bill back system that lowered the utilities expenses to the owner by $300 per month.  The $100/mo income increase x 4 units is $400 per month, $4800 per year.  And the expense savings of $300 per month, $3600 per year savings translates to a total of $8,400 increase in the Net Operating Income.  If you apply the 7 cap rate to $8,400 per year ($8,400/.07) you have added $120,000 to the value of the building at the same cap rate.  Welcome to income property investing!

In the current financial environment, residential real estate investing continues to be a viable business, but the business has changed dramatically.  There are more challenges and deals require different credentials and strategies compared to recent years of loose lending standards and appreciating prices.  Private investment placement managers and established cash buyers are squeezing out the “mom and pop” investors because of lack of funding.  .

The housing market, driven by Wall Street speculation and mortgage backed securities, peaked in 2005, softened in 2006, crashed 2007-2008 and is now bottoming in 2009 in many markets.  Prices of houses and condos nationally have dropped significantly as has the number of homes being sold. The record number of foreclosures combined with a melt down in lending has created disastrous effects on the economy and changed the business models of most real estate professionals.

Like the businesses of real estate agency and mortgage brokerage, a cleansing of the real estate investment industry is occurring.  The Fix and Flippers of the boom years, mostly people who used 100 percent mortgages to buy appreciating houses for quick resale and profits have disappeared in most markets.  The real estate investors left over (the ones still in business) are well capitalized and using a buy and hold rental model.  Many are turning to private equity instead of banks and credit unions.

One major exit strategy for investment companies now is to sell the properties to passive investors who are getting into real estate as an adjunct to their regular jobs.  They are known in the business as “retail” investors.  These types of investors can still secure financing on investment property, and the companies servicing them successfully are providing the closest thing to triple-net (NNN) investment that the housing business has (NNN is a commercial real estate investment type where the owner is not responsible for any of the maintenance or expenses of the income property).  Pure passive investments in single-family were once difficult to find, but there are more service companies providing these opportunities than ever before.   There is also more demand from investors as money pulled from the market sits idle and falling to inflation in zero to low interest accounts.

In addition to the turn-key investment business model for retail investors, high-quality rehab and resale to first-time home buyers will work in some markets.  The first time home buyer market will be less affected because the buyers do not have any “baggage” – they don’t have to sell a property to upgrade.  Also, the loan programs for this type of borrower are healthier than normal conforming loans.

For most of my real estate investment career, finding the deal was the difficult part of the business.  Once you contracted a good deal, the capital was easy to find and it was relatively easy to sell.  That has all changed now.  There are properties at good values available everywhere from banks and motivated sellers, but the capital and sales are hard to come-by.  Once again, we real estate professionals and investors must reinvent ourselves to adapt.

I like the quote from Warren Buffet, “Be greedy when others are fearful and fearful when others are greedy.”  As difficult as it may be, I continue to recommend our clients invest in quality real estate now during the down cycle.  Please let me know I can be of assistance to you in any way.

One of the ways that I evaluate the level of sophistication of fellow real estate investors, and potential clients, is the answer to this question:  “What is your acquisition criteria?”   More often than not, the answer is “I just want a good deal,”  which is usually a sign of a novice investor.  Experienced investors know exactly what they are looking for, and can explain how and why that criteria fits into their overall investment strategy.  If your new client is a novice investor, the best place to start is working together to establish an acquisition criteria.

The following is an example of an investor criteria that I use as a starting point for discussion.   I work with clients to modify it to create and then meet their goals.  This process helps me serve them better and saves lots of time for everyone during the search and acquisition phase. 

Example Single Family Rental Acquisition Criteria:

• 3 bed / 2 bath  minimum (or 2 bed / 1 bath w/ full basement)
• Brick or modern frame
• Ranch or two story structure
• Finished  or open basement
• Minimum 1 car garage, preferably 2 car
• Above average street scene, especially next door neighbors
• $50k – 150k purchase price
• $120k – 250k ARV (after repaired value)
• $10k – 40k rehab costs

Exceptions and Other considerations:

• Will buy 2/1′s but it must have either a basement or a garage.  Without either, no deal.
• All houses should be larger than 800 square feet on main level
• Will buy frame houses must be newer than 1975
• Prefer ranch style, will buy bi-level, two story, story & 1/2 but don’t like tri-level

Deal breakers:

• Nothing directly on / or within a block of / or backing to a major street
• Nothing within 2 blocks of a highway
• Nothing immediately next to / or within direct view of commercial/industrial, grocery store or muffler shop, etc.
• Nothing older than 1920 (see related post titled “Why I will Never Buy Another Victorian”
• Nothing with a functionally obsolete layout (tiny bedrooms, no closets, only bathroom off the kitchen, etc.)

Will pay a premium for properties that:

• Need less than 20k rehab
• Next to park or green space
• Larger lots zoned R2

Proper planning for an overall objective in your real estate investments is a critical step toward realizing goals.  Determining an Acquisition Criteria is just one of those steps.   Without this process, it is too easy to become emotional about deals, properties and opportunities.  “Failing to plan is a planning to fail” is so true in this business.  Happy Investing.