The real estate blog.

Today we have a special guest blogger to tackle the topic of getting into real estate investing. Byron Goates is the licensed Principal Lending Manager (PLM) and owner of Integrity First Financial. He has worked on hundreds of loans for investors and home buyers alike as well as being an avid investor himself. This is the first in a series on how to get into real estate investing.

I recently got a call from “Bill.” He was out in the snowy weather installing a fire sprinkling system on a million dollar house. He said he was cold and wet and he had to get out of his business. He really wanted to get into real estate.

This is not the first time I had heard from Bill. Bill was in my office last summer after being referred to me by a person I know at a title company. At the time, Bill was working with a realtor and looking to buy an investment property in his neighborhood.

The home he was looking at was a single family home on a nice street in a quaint older neighborhood. The homes in the area were all similar small brick bungalows. These homes 3 years ago were going in the $180 – $200k range but had sky rocketed recently.

The realtor he was working with claimed the home was a great deal at $325k and could go up to $360k with a little fix up. Bill did the math and figured $35k is not a bad profit. If he could do one of these a month and fix it up, he could make a good living.

Before we addressed the property, I took a loan application from Bill. The first thing out of Bill’s mouth was that he needed to do “a 100% stated income loan” because he wrote off everything to minimize his income. I then determined that Bill had $20k in his 401k and under $2k in checking and savings. The realtor had prepped Bill because she knew of his financial situation. It seems like realtors are acutely aware of the 100% stated income investment loans.

Before I moved forward, I thought it best that we go over the purchase that Bill was contemplating. Bill’s house payment on the 100% stated income loan was going to be about $2500 a month and the sellers were going to pay for most of the closing costs. So he was going to get into this home with less than a thousand dollars down.

I asked him how much he would spend on the fix up and he thought about $5000 in materials and a month’s worth of his work. I asked him how he was going to sell the house after he had is ready to go. He said he was going to list it with the same realtor that was trying to sell him the house and that she would cut her commission in half when he went to resell the house. My final question was; what was he going to do if the house didn’t sell right away and his answer was to rent it out while he was trying to sell it.

I now had enough information to let Bill know the reality of what he was about to do. First we needed to subtract out the fix-up costs, the real estate commission, sellers fees to resell the property and then interest costs for the 4-6 month project.

The math went like this: real estate commission (4.5% of 360k) $16,200, hard fix-up costs $5000 (assuming no surprises), 4 months loan carrying costs $10000, $2500 closing costs on the sale. This assumes the house would sell for $360k and there would be no seller paid buyer closing costs.

His best case scenario would be a $1300 profit if he sold it after 4 months for $360k and a loss if it sold even a month later. If it didn’t sell and he decided to rent it out, rents for the area are $1200 per month, so he would bleed $1300 per month in negative cash flow, let alone the difficulty of trying to sell a property that is being rented.

After doing the math we determined that this was only a good deal for the realtor. The risk-reward numbers just didn’t add up. Being that there had been a 50% increase in value in the neighborhood, appreciation was unlikely to bail him out.

We decided it was in his best interest to pass on this one. Needless to say, the realtor was not happy. She was probably kicking herself for not pushing him to use her “mortgage person.”

There are a number of lessons we can take away from this story.

If you want to “get into real estate” make sure you have someone you can trust show you the ropes and the reality of the numbers
Real estate moves in cycles and you don’t want to be late to the gameNo money down financing is an expensive and risky way to purchase an investment propertyReal estate investors really need to have some financial reserves in case things don’t go as plannedIt’s sometimes difficult to trust someone’s advice when their commission is riding you taking their adviceHomes that have been offered on your market’s multiple listing service for more than a week are retail deals and investors need wholesale deals

The next column will be devoted to those who really want to get into real estate and are willing to do the work to get the best deals.

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Byron Goates
Integrity First Financial
byron (at) integrityloans.com
801-474-3333 ext. 202