If you're still interested in learning more, sign up below or check us out on our other platforms:
Sunday, September 15, 2019
New Website, Blog, and Social Accounts
As some may notice, I haven't posted in a while! This is because I've moved to an official site back in May!
If you're still interested in learning more, sign up below or check us out on our other platforms:
If you're still interested in learning more, sign up below or check us out on our other platforms:
Thursday, February 7, 2019
Deal or No Deal? (with spreadsheet)
While many deals come through my inbox every day, there are only a handful that make it into my underwriting spreadsheet for review. Here is an example of a deal that came across today, and how I analyzed it:
Email:
From first look, there could be a solid flip play here, and possibly a buy and hold rental as well. After getting a rehab estimate it looks like it will be close to 75k in repairs. The wholesaler also may provide a pro forma that usually consists of a spreadsheet that shows the financial projections of the property for various scenarios such as flipping vs buy and hold. After looking at the estimates, it is still looking like a decent deal with an estimated return on investment of close to 18% on a flip, and around $150 cash flow after refinancing for a buy and hold.
At this point, it is easy to get caught up in excitement over the deal and want to dive right in. That's where it is important to take a closer look at the assumptions and calculations for various metrics. I've simplified this process by creating my own underwriting spreadsheet for Philadelphia properties. There are a few inputs that I enter into the spreadsheet (usually easy to pick out from the provided pro forma), and then I let the numbers speak for themselves. The metrics are then defined in a manner that is most useful for me to compare with other deals and investments.
For me personally, the ultimate metric is the return on investment (ROI). For a given amount that is invested into the property (after moving into long term financing on a buy and hold or selling the property in a flip scenario), what is the annualized rate of return? This metric can be compared across assets and ultimately lets me know how well I am doing in my investment strategy. In my opinion, if I am an "active" real estate investor and am unable to beat 10%+ in annualized returns, then I really should move into passive solutions such as the stock market or better yet passive multi-family syndications (ask me more about how to get into multi-family investments if interested).
Back to the example. After digging a bit into the calculations, it was clear to see that the metrics in the pro forma were not aligned with what I actually cared about. There were also missing expenses that I knew of based on my previous experience owning property in Philly (property management, city utility, etc). Another item that was overlooked was the fact that when purchasing through an LLC, you are no longer eligible for conventional financing, so you need to underwrite a higher longer term loan rate than you normally would (for example, the commercial long term rate is closer to 7% instead of the conventional rate which is around 5.7%). When you add in realistic expenses and loan data, it is easy for a deal to go from good to just mediocre, so it is important that you don't shrug off these details in order to justify the deal!
I’ve included my spreadsheet below. As you can see, this deal ended up looking pretty mediocre in the end, so I passed on it. Better to have a few quality deals than a bunch of mediocre ones, especially in a hot market like we are currently in. The cash flow turned from +$200 to -$500 after the analysis, and the flip play actually turned out a bit better (30% ROI) than originally projected*.
To summarize the sheet, make sure you include the following in your analysis:
*This has been a general trend I’ve been seeing lately when any type of private financing is involved; the buy and hold deals just really have not been looking good in terms of cash flowing and the flip play seems to be the best option right now.
Email:
I just got a very clean opportunity in Philadelphia that we are selling for 120k. The property is 1,216sqft on a 16x73 lot with 3 bedrooms and one and a half bathrooms. The property needs cosmetics throughout, a finished basement, and added AC. That will get you to our 245k comps all day long- 25 S 53rd sold for 230k after 15 days on market 5328 Locust sold for 240k after 7 days on market (No central air, partially finished basement) 34 S 53rd sold for 250k after 12 days on market 132 S 53rd sold for 260k after 40 days on market. If you want to rent this one out you will get at least $1,100 a month no problem and it will only require a very minimal rehab. Get with me ASAP for more info or access
Analysis
First off, note the urgency of the email and the feeling of scarcity that it provides (that "once in a lifetime opportunity" type of feeling). This is how many wholesalers come across. It's not necessarily a bad thing. They are trying to sell houses, so I understand the sales pitch style. Just make sure you don't get too caught up in it and remember to step back and analyze the deal objectively.From first look, there could be a solid flip play here, and possibly a buy and hold rental as well. After getting a rehab estimate it looks like it will be close to 75k in repairs. The wholesaler also may provide a pro forma that usually consists of a spreadsheet that shows the financial projections of the property for various scenarios such as flipping vs buy and hold. After looking at the estimates, it is still looking like a decent deal with an estimated return on investment of close to 18% on a flip, and around $150 cash flow after refinancing for a buy and hold.
At this point, it is easy to get caught up in excitement over the deal and want to dive right in. That's where it is important to take a closer look at the assumptions and calculations for various metrics. I've simplified this process by creating my own underwriting spreadsheet for Philadelphia properties. There are a few inputs that I enter into the spreadsheet (usually easy to pick out from the provided pro forma), and then I let the numbers speak for themselves. The metrics are then defined in a manner that is most useful for me to compare with other deals and investments.
For me personally, the ultimate metric is the return on investment (ROI). For a given amount that is invested into the property (after moving into long term financing on a buy and hold or selling the property in a flip scenario), what is the annualized rate of return? This metric can be compared across assets and ultimately lets me know how well I am doing in my investment strategy. In my opinion, if I am an "active" real estate investor and am unable to beat 10%+ in annualized returns, then I really should move into passive solutions such as the stock market or better yet passive multi-family syndications (ask me more about how to get into multi-family investments if interested).
Back to the example. After digging a bit into the calculations, it was clear to see that the metrics in the pro forma were not aligned with what I actually cared about. There were also missing expenses that I knew of based on my previous experience owning property in Philly (property management, city utility, etc). Another item that was overlooked was the fact that when purchasing through an LLC, you are no longer eligible for conventional financing, so you need to underwrite a higher longer term loan rate than you normally would (for example, the commercial long term rate is closer to 7% instead of the conventional rate which is around 5.7%). When you add in realistic expenses and loan data, it is easy for a deal to go from good to just mediocre, so it is important that you don't shrug off these details in order to justify the deal!
I’ve included my spreadsheet below. As you can see, this deal ended up looking pretty mediocre in the end, so I passed on it. Better to have a few quality deals than a bunch of mediocre ones, especially in a hot market like we are currently in. The cash flow turned from +$200 to -$500 after the analysis, and the flip play actually turned out a bit better (30% ROI) than originally projected*.
To summarize the sheet, make sure you include the following in your analysis:
- Your actual financing costs if using private money (sometimes you have to ask several times to get all the various fees down, but make sure you do it)
- If buy and hold, make sure you are using a realistic rate (usually 1.5% higher than the conventional investment property financing rate) and using the appropriate LTV (75% for SFH, 70% for small MF)
- Inspection costs
- City specific costs (e.g. $300 garbage fee in Philadelphia for an investment property with 2+ units)
- Include all of the above costs in your calculation for ROI
- Take a much closer look at comps. It is very easy to group a couple of properties and say they are comps, so make sure you validate the assumptions and do your own due diligence there. Making a large mistake on ARV can completely destroy a deal and can make a deal much more risky than you thought it was.
*This has been a general trend I’ve been seeing lately when any type of private financing is involved; the buy and hold deals just really have not been looking good in terms of cash flowing and the flip play seems to be the best option right now.
Monday, January 7, 2019
Cash-Out Financing
It is now almost the end of the seasoning period for my duplex in Philadelphia, PA. A seasoning period is the minimum amount of time required to use conventional cash-out financing; federal regulations dictate 6 months. Conventional cash out financing usually gives the buyer the best terms and lowest risk. There are ways to cash out finance earlier, but generally they require the property to be a Single Family Home (SFH) or a loan from a private lender.
I purchased this property originally as an all cash deal and did a rehab on the property to force appreciation so that the value of the asset after my repairs is higher than the cost of the purchase + renovation. There is a similar concept in cash-out refinancing a property. This occurs when the property has an existing mortgage and you simply pay off the balance on the old loan using the new loan. Any additional value left over after the minimum required equity (think down payment), can be taken out as cash. In the case of my property, I'll be financing it for the first time and pulling out as much equity as possible in the form of cash so that I can put that capital into new deals.
Do note that a cash-out (re)finance is a loan; there will be a monthly payment that includes principal and interest that you'll need to take into account before deciding to use this type loan. Investors use it so that they can recoup their initial investment and put it back to work in an asset that will outperform the interest rate on the loan (e.g. in another property).
A second step, which must be done carefully, is ensuring that the property is at least temporarily owned by you, the individual (unless you are at your personal loan limit of 10, but that is a topic for another time). If you purchased the property under an LLC, these conventional mortgages will not be available to you. The property needs to be owned by an individual to qualify for the type of conventional cash-out financing. Again, there are ways to do a cash-out finance under an LLC, but this will require a different type of loan that will not command such good terms.
The process is pretty simple afterwards. The lender will require an appraisal involving an inspection and evaluating comparables in the market. It doesn't hurt to send the comparables you originally used in your underwriting to the lender, as this shows that you‘ve been doing your homework and will get your target numbers top of mind.
The financing will then be dictated by the appraisal and the Loan to Value (LTV) for your home type. For Single Family Homes (SFH), you typically have to leave in 25% equity in the property (i.e. LTV of 75%). For small Multi Family Homes (MFH), you are generally required to leave in 30% equity (70% LTV). Keep this in mind when analyzing your cash flow after financing. The rest of the loan value will be available to you as a cash deposit.
Ideally the delta between the appraisal value and the purchase price + rehab cost + equity required to remain in the property (25%-30% depending on the property type) is greater than or equal to zero, meaning that you were able to get your original investment (or more) out of the property.
If there is additional equity that can be extracted beyond the original investment, you have a couple options depending on your goals and risk tolerance. Leaving more equity in the property increases cash flow since the mortgage payment will be smaller. Increased cash flow leads to less risk since you'll be able to profitably weather any rent drop storm that could come your way in a declining economy. Furthermore, leaving more equity in the property will lower your Debt to Service Coverage Ratio (DSCR), which can be important for getting lending in the future (especially in a declining economy).
At this point in my business and with the state of the economy, I prefer to leave the extra equity in the deal, creating more profit available on a monthly basis. If I were doing more deals per year or if the market was in a better state, I may take the cash so that I could sustain funding more deals. It all depends on your individual business strategy.
Here is an example chart illustrating the various parts of the initial investment and the cash out loan:
Don't necessarily go with the first lender you meet. Shop around! Really do your homework and get the best terms. This will affect cash flow and is worth the time and effort. Once you find a good broker for your area, you are set for the rest of the properties that you will finance.
I purchased this property originally as an all cash deal and did a rehab on the property to force appreciation so that the value of the asset after my repairs is higher than the cost of the purchase + renovation. There is a similar concept in cash-out refinancing a property. This occurs when the property has an existing mortgage and you simply pay off the balance on the old loan using the new loan. Any additional value left over after the minimum required equity (think down payment), can be taken out as cash. In the case of my property, I'll be financing it for the first time and pulling out as much equity as possible in the form of cash so that I can put that capital into new deals.
Do note that a cash-out (re)finance is a loan; there will be a monthly payment that includes principal and interest that you'll need to take into account before deciding to use this type loan. Investors use it so that they can recoup their initial investment and put it back to work in an asset that will outperform the interest rate on the loan (e.g. in another property).
The Process
The overall process is pretty straightforward and simple. First, shop around locally and tap into your network to see which lender has worked best for others. Generally, a bank local to the area of the property will be your best bet. For Philadelphia, I've been working with Mike McKeown over at Allied Mortgage Group. They are local to the area and seem to provide the best rates. I also have others within my network who have used him successfully before.A second step, which must be done carefully, is ensuring that the property is at least temporarily owned by you, the individual (unless you are at your personal loan limit of 10, but that is a topic for another time). If you purchased the property under an LLC, these conventional mortgages will not be available to you. The property needs to be owned by an individual to qualify for the type of conventional cash-out financing. Again, there are ways to do a cash-out finance under an LLC, but this will require a different type of loan that will not command such good terms.
The process is pretty simple afterwards. The lender will require an appraisal involving an inspection and evaluating comparables in the market. It doesn't hurt to send the comparables you originally used in your underwriting to the lender, as this shows that you‘ve been doing your homework and will get your target numbers top of mind.
The financing will then be dictated by the appraisal and the Loan to Value (LTV) for your home type. For Single Family Homes (SFH), you typically have to leave in 25% equity in the property (i.e. LTV of 75%). For small Multi Family Homes (MFH), you are generally required to leave in 30% equity (70% LTV). Keep this in mind when analyzing your cash flow after financing. The rest of the loan value will be available to you as a cash deposit.
Ideally the delta between the appraisal value and the purchase price + rehab cost + equity required to remain in the property (25%-30% depending on the property type) is greater than or equal to zero, meaning that you were able to get your original investment (or more) out of the property.
If there is additional equity that can be extracted beyond the original investment, you have a couple options depending on your goals and risk tolerance. Leaving more equity in the property increases cash flow since the mortgage payment will be smaller. Increased cash flow leads to less risk since you'll be able to profitably weather any rent drop storm that could come your way in a declining economy. Furthermore, leaving more equity in the property will lower your Debt to Service Coverage Ratio (DSCR), which can be important for getting lending in the future (especially in a declining economy).
At this point in my business and with the state of the economy, I prefer to leave the extra equity in the deal, creating more profit available on a monthly basis. If I were doing more deals per year or if the market was in a better state, I may take the cash so that I could sustain funding more deals. It all depends on your individual business strategy.
Here is an example chart illustrating the various parts of the initial investment and the cash out loan:
In this hypothetical example, the initial investment includes the purchase price and rehab ($50k + $15k) and is shown in the first column. The After Repair Value is $100k. With a cash-out loan at 75% LTV, that allows for the borrower to pull out $75k (green + red section). After recouping the initial investment of $65k, there is an additional profit of $10k left over. As mentioned before, I prefer to leave any such profit in the property itself to increase cash flow.
Things to Watch Out For
It is key to watch out for a due-on-sale-clause."A due-on-sale clause is a clause in a loan or promissory note that stipulates that the full balance of the loan may be called due (repaid in full) upon sale or transfer of ownership of the property used to secure the note. The lender has the right, but not the obligation, to call the note due in such a circumstance."If you are taking the loan out as an individual (as you'll be required to do) and transferring it back to the LLC after the financing has occurred, make sure that you don't trigger an effective "sale" of the property (since it is technically transferring owners) as that will result in requiring capital to cover the full value of the outstanding loan in addition to transfer fees and tax transfer costs that you really do not want to have. Some banks will work with you to avoid this, others will not. Make sure you know the situation before making any transfers!
Don't necessarily go with the first lender you meet. Shop around! Really do your homework and get the best terms. This will affect cash flow and is worth the time and effort. Once you find a good broker for your area, you are set for the rest of the properties that you will finance.
Subscribe to:
Posts (Atom)