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Real estate notes Vacancy rate indicates the situation in the residential market. A high vacancy rate, i.e.

many units do not have tenants or owners, means the demand is low and vice versa. Less than 5% vacancy is a low rate. Demand is driven by both tenants and investors. Therefore possible to have different views of the market. Difference in interest: occupying or investing. Price of an investment property is driven by the investor demand, not tenant demand. Price is also distorted by local government intervention. Cash flow analysis: 1. 2. 3. 4. 5. 6. 7. 8. cash for down payment price of property interest rate and mortgage payment recurring expenses: insurance, tax, utilities rental income personal financial situation incidental expenses: repairs, landscaping, pest control, alarm system tax deductions

Cash flow more important than appreciation in value. If there is a negative cash flow but appreciation in value, youre still losing money, you can only afford it for a certain time and you need to have a plan to get positive again. Buy the worst house on a good block. A good block: - quiet in terms of traffic/noise - well-maintained - low crime - few or no vacant lots in vicinity - convenient for shopping and transport - residential or residential/commercial zoning NOTES FROM RICH DAD: REAL ESTATE Residential real estate: When you buy a condo or house to rent it out, the appreciation of the property rests solely on the appreciation of the surrounding neighbourhood. The neighbourhood is therefore critical. Commercial real estate, e.g. apartment complexes, the appreciation is based on the cash flow of the property itself. This leaves the owner in control of the propertys value. Larger properties are also less risky because of occupancy. If one tenant moves out, the property still makes money. If a tenant moves from a single residential unit, it doesnt make any profit at all. Steps to running a real estate business:

1. 2. 3. 4. 5. 6. 7.

Team, staff, connections Evaluate market Find a property Valuate property Establish property plan Develop budget Manage property

You need experts on your team. Without experts deals take longer to find, evaluate and close. There is the value of your time and loss of opportunity to not having a team. Do it yourself and you miss important deals, and details to existing deals. Includes: accountant, appraiser, architect [if necessary], insurance agent, property tax consultant, income tax consultant, environmental company [mold, asbestos etc.], surveyor [if necessary], structural engineer, lawyer, property manager. Research market: Step one: at home research. News that defines a market: population growth, school funding, urban growth boundaries [limited supply], transportation [public transport, highways, employment situation, lack of affordable housing, buy low sell high: down economy. Major employers. Step two: go to city. meeting with potential team members. Phone calls to property managers, commercial brokers, commercial lenders, business people [e.g. publisher of local apartment guide] city officials etc. Hold meetings, clarify, verify your Step One research. Ask for referrals for lawyers, contractors, property management people, accountants etc. Ask for recommendations for all team members mentioned above. Team can give leads. In economic downturn, look for which part of the market will pick up first. E.g. downtown area. Step three: contact referrals from Step two. Gained opinions and insight from Step two, websites, analyst news letters, economic development office, city officials contacts. Select team members to hire: real estate agents, commercial brokers, loan officers, other professionals. Involve others to maintain your objectivity, keep your perspective. Demand: amount of people looking to rent. Ask brokers and property managers. High occupancy rate means high demand. Move in incentives are sigh of low demand. Future supply: construction, planning, permitting etc. Ask about this. Supply: Have them provide detailed data; property names, size, address, date of construction. Drivers of supply and demand: 1. Employment. Stability of the industry. 2. Population: area with character. New high ways, planned communities, sports facilities, universities, redevelopment, world events, company relocations, regional airports, etc. resilience: not reliant on just one big employer. Economic diversity. Affordability: if single family home is expensive, rental becomes attractive. 3. Location: Drive by visibility. Special quality, like beautiful surroundings. High demand: can base offer price on operational performance rather than sellers offer price.

Have clear definition of target property: type, monthly yield, what market and submarket etc. look for property that matches your demands. Get property close to where you live: travel costs, risk of forgetting about the property, perception that it is an investment, not a business, lack of information because of distance. Given the parameters, look for individual property. Property targeting within the sub-market. Read everything about that sub-market. Crime, new retail places and their success, traffic reports, landmarks, rezoning, etc. Look around the area. Verify all leads!!! Separate fact from opinion. Join local trade association. Look out for specialized broker. Knows about new stores, highways, employment situation etc. No upfront cost! Good broker will focus on building relationship. If there is nothing in the target sub-market for sale, can contact owners directly. Information available with government agencies. The research phase is all about becoming an expert in the local area. Cold calling residents is also research. Evaluate individual property: Key to the deal is if the numbers work out. Dont buy property on ask price, but on operational performance. Asking price is irrelevant. Your offer is determined by property value, which is based on current cash flow of property. In a nutshell: 1. Property income 2. Property expenses 3. Net operating income 4. Capitalization rate and valuation 5. Loan cost and profit on cash Arrive at offer price. Property income: if seller discloses it, must verify. Residential mortgage is secured by property itself. Investment property is secured by income generating potential of the property. Actual income: total income generated in prior twelve months. Actual potential income: total income the property could have generated in prior twelve months, at 100% occupancy, and all other available income opportunities had been realised.

Future potential income: total income property could generate at todays market rents, 100% occupancy, all other opportunities realised. Buy at actual income. When price is lower, so is your mortgage. Numbers given by seller are often inflated. The rent schedule pro forma is seldom based on actual income. Ask for actual rent, request rent roll, use those numbers for calculations. Now, actual potential income is verified. But often not 100% occupied. Look into occupancy, vacancy rate and turnover. Income from other sources too. Often inaccurate. Property manager can verify the turn over, vacancy rate, and if it is below or above market average. Vacancies an indicator of supply and demand in the market. Difference between seller pro forma income and rent roll income: bargaining chip. Because numbers are real, they are defensible in negotiations. Rent rates may be below market price! Expenses: Net operating income = income expenses. Expenses difficult to nail down exactly, but can arrive at a close idea. Take property manager to help you assess everything involved in running the place. Ask him to come along, Im not sure if I want to manage it myself or have a company do it. This way you find out what it takes to run it, and how to minimize expenses. Get an idea of the upgrades necessary or available, repairs, ongoing services. Analyze if repairs still make it profitable. Pro forma expense table, with projected expenses for coming year. If repairs are projected to be the same as last year, it is probably inaccurate, as repair and maintenance costs go up when property ages. Contact utility company to ask about increase in utility fee. Use previous years expenses and assume some increase. Talk over with property manager, broker. Property sale tax also based on price! So must keep low! Property sale can increase tax. Ask property tax consultant. Get insurance agents to bid on the property. View replacement reserve. If seller did not spend anything on repairs, it means youll have to. Deferred maintenance. Repairs and maintenance: property manager. Insurance: call the company. Utilities: same. Tax: call government office, tax consultant.

Expenses: repairs and maintenance, insurance, utilities, tax, replacement reserve. Net operating income: you will base your offer on this number. Does not include cost of money, loan payment. Capitalization rate: net operating income divided by purchase price. In this equation, use purchase price trend for comparable building in this market. Can be obtained from brokers. So, to calculate value of this individual property, take net operating income and divide it by capitalization rate. This is your offer price. Loan payment: can be found from mortgage supplier websites, companies. Take offer price and down-payment. Actual profit: subtract loan payment from projected net operating income. Purchase process: Once you have to numbers, base your deal on that. Cannot continue because emotionally involved in the deal. Present offer price based on the numbers. Seller knows its a fair price. Send letter of intent, get property off the market. Tie it up. Must do steps from last part within 48 hours. Streamline the process. The quicker you can tie up a property the better. Property no longer available to competitive bidders. Letter of intent before purchase contract. Use this for negotiation, makes purchase smoother. At this time, relationships need to be established. Have team in place to do steps above quickly. Time is of the essence, use courier delivery for documents. Include in contract: purchase price, down payment, escrow/deposit, who holds the escrow, when is it non refundable, time frames, how are taxes, rents, insurance etc. split between buyer and seller, when will title report be delivered, financing arrangements do you need to take on an existing one, due diligence time frame, time frame for pest control inspections, representations/terms on mold, lead-based paint etc., time frames for physical inspections. All units must be rent-ready at close of escrow. Use lawyer for this. Contingencies: provisions in contract which allow you to cancel the deal, e.g. cannot get finance, loan contingency, due diligence contingency. DD: As a buyer you must be entitled to any and all documents related to the property, ask as many questions as you like. Must provide for in contract.

Due diligence contingency must allow you to walk away, extend your dates, or adjust offer price based on findings. Due diligence: Thirty days. Detailed assessment of actual costs for property improvement, maintenance and operations. Any finding that could cost you money is a bargaining point. Take inspector with you. He may also point out opportunities to make property more profitable. Actual potential income: do the facts on the ground match the numbers on paper - signed rental agreement on every unit - monthly rental rates from rent roll match numbers in your offers - security deposits match - do residents pay in time [rent details], complaints, credit and criminal background lifestyle of residents whether all units actually have residents living in them missing furniture, appliances etc. damage to property [fire, resident etc.] signs of pest problems Compliance with government regulations fire code violations outstanding permit problems environmental concerns: asbestos, mold etc. ownership issues, zoning violations, encroachment on property etc. Service agreement: improvements, cut costs pool service heating, AC, cooling agreements landscaping contract laundry machines cable, alarm parking advertising exterior inspections roof problems, leaks etc. condition of heating, ventilation and cooling systems electrical wiring plumbing paint condition of driveways and parking lots landscaping

Put an estimated cost on every item. Inspect books and records: Gather information on operating budget. - View 24 months of income and expense statements. Make notes on the operating budget. - View all service agreements: termination clauses longer than 30 days. Check if the costs are in the operating budget, if the service is needed, can it be obtained cheaper, are services missing. Determine whether they stay or go. Cannot be locked into them. - Check current rent roll. Take a good look at any unit that is below market value. - View utilities bill. Call utility company to ask about increases, check and verify. Insert figures in budget. - Payroll information if there is any staff. Treat as new hires, find out about vacation time, credit and criminal record. All information discovered here is additional information for next round of negotiations. Can also land you new team members, leads, etc. Have team give opinion on the information compiled. Ask tax accountant, property manager, insurance agent [e.g. take measures to make property safer, lower insurance], contractors etc. Look for washing units, units with good view [increase price], features that can be improved, access gates. The property itself should be showing you the money. Team members will see opportunities too. That is how you make money. Consider: - what will happen if you increase rents - what would you do to attract new residents is there a system? is the newspaper ad worth it? - If you add features, would residents pay for it? - Replace v repair - Can I bid out landscaping, maintenance - Energy efficient lightning - Hire own maintenance staff Prepare a budget View all income: rental and other. View your expenses: payroll for staff, administrative costs, like lawyer, accountant, background checks, advertising, management, repair and maintenance, property tax, insurance, utilities, capital repairs. When you confront seller with findings, need to be professional and friendly, cos seller can be buyer next time, or have a referral etc. Adjust offer slightly for repairs.

Property management company Once bought, engage a property management company. Check if they have good systems in place. Ask about their procedures. Company will attract the residents, do advertising etc. and background checks. They can also help increase cash flow, do the legal work, maintenance, collect rent and administer late fees. No grey area for late or no payment. Never allowed. With every exception, you set a precedent. Company can also manage the budget. Consult attorney for eviction. Property management is not the place to cut corners. Without proper management, cannot increase value of property. Property management fees: 8-12% of gross rent. Three years experience. Several accountants. References. Membership with professional associations. Good training programmes for staff. View their policies and procedures to see how they work. Ask for their licenses. Ask who they use for evictions and background checks. Explain how they have negotiated with vendors to lower the price. Know the actual individuals who will be running the company. When to fire: they dont communicate important things like changes in market conditions. They neglect the physical condition of the property. High employee turnover. Incomplete reporting. Maintain a reserve fund for little incidents that are below your insurance deductible.