Connect with us

Real Estate Investing

Not A Citizen? Here’s How to Invest In US Real Estate.

Published

on

Everyone wants to buy US real estate because of the regulatory environment, stability, and economic growth. But, many people pass it over.

The number 1 reason people don’t invest in real estate is the perceived risk of it. That could come from a number of factors, but often it’s because you don’t live geographically near the property you want to buy.

Another reason might be that you aren’t a citizen of the country you want to make the purchase in. This is incredibly common for people who want to invest in the US but live abroad or are citizens of other countries.

Sure, it sounds like a great idea, but how are you going to buy and manage something on the other side of the planet in a country you don’t really know?

But, did you know that it’s not hard to invest in US real estate even if you live abroad and are a citizen of another country?

Sure, there are some considerations you have to make and hoops to jump through, but it’s totally doable.

Why US Real Estate?

Once you’ve decided to invest in another country, you need to ask “why invest in US real estate” and not somewhere else. As a real estate investor you don’t want to limit your options.

Well, recently the US real estate sector has separated itself from other sectors in the US as well as from real estate in other countries.

The financial crisis is in the rear view mirror and the US economy is fueled by strong business and job growth. The US has a very stable real estate market and mature capital markets which compare positively to other countries.

Europe, being its most comparable area, has been embroiled in one economic crisis after another from Greece to Italy to Spain. Brexit, and strain on the welfare state from migration are just the most recent which can seen with widespread protests in France.

From a more micro perspective, US real estate has a lot of mature cities that have a lower cost than in many international cities such as London or Tokyo. While the US does have very expensive markets such as Los Angeles or New York City, there are a lot of core markets that offer good returns at a lower price point.

Additionally, the U.S. market is more liquid than other markets around the world and much more massive. So, it’s comparatively easy to sell and reinvest your capital somewhere else should your personal situation change or should economic conditions dictate your need to sell.

While there are a lot of great reasons to invest in the US, there are a lot of hurdles as well.

Hurdles You’ll Face as a Foreign Buyer of US Real Estate

Image result for hurdles

It easiest for U.S. Citizens and permanent residents to purchase US real estate. Foreigners have a more difficult time and have more hurdles to overcome. So, let’s talk about all the drawbacks you will face as a foreign buyer of US real estate.

No Fannie Mae and Freddie Mac

In the residential real estate market (1-4 units), Fannie Mae and Freddie Mac are the king of the home loan. Basically, they guarantee or purchase the majority of home loans so when they set standards, most banks and lenders follow suit. Unfortunately, they do not purchase loans from non-US citizens.

So, these are not an option for foreign buyers. You’ll have to focus on finding lenders that keep the loans on their own books and don’t sell them to Fannie or Freddie.

The problem for banks is that these loans are harder to sell on the secondary market. Foreigner buyers have a higher risk of default and it’s more difficult to collect unpaid balances if they live overseas. So, you will have a harder time qualifying and pay higher interest and fees to offset the risk they face.

Mortgages to Foreign Buyers Have Higher Interest

There are plenty of banks that will lend to a foreign national who lives outside of the United States, but they have to create loans that don’t conform with Fannie or Freddie guidelines and have to keep them on their own books.

So, they charge higher interest and higher processing fees.

They will also require a larger down payment to give them some more room in the chance that you default. Often they will require 30% or more as the down payment.

Generally, a bank looks at your income, your expenses, and your credit history to determine if you are qualified for a loan. For foreign buyers, it’s a lot more difficult for them to verify these things.

So, they will ask for a lot more documentation than they would ask of an American real estate buyer. This may include tax returns, bank statements, and any credit history available in your home country. They may require several months worth of bank statements, credit statements, and a huge variety of other documents, all of which is just to make them feel more comfortable extending a mortgage to you.

Because of all this extra underwriting, it will take longer for your loan to go through and finish processing.

To speed this up, you might want to apply for a loan at a bank in your home country that also does business or has a presence in the US. The bank will be able to verify your information more easily, but also extend credit in the US.

Fannie Accepts Green Cards or Work Visas

Fannie backed loans or FHA accept work visas. So, if you happen to be in the US, even for a short period of time, you may be able to qualify for one of these.

There may be some additional documentation requirements, but having FHA or Fannie backed loans will open a lot of doors, lower your cost and down payment requirements.

How to Invest in U.S. Real Estate

We’ve covered all the reasons to invest in the US and also all the difficulties you’ll face when trying to get a loan. Now it’s time to cover some basic information to help you get started as a foreign real estate investor buying US real estate.

The first thing to consider is what niche in real estate you want to get into.

Residential vs Commercial Real Estate

For some reason, residential real estate is considered any building with 4 or fewer living units in it. It is not exclusive to single family homes or condos which is great for investors if you want to get into small multifamily!

5 units and above multifamily is considered commercial, even though it’s residential living space. Also, all commercial office space, retail, etc is considered commercial real estate. This includes single occupancy buildings such a standalone pharmacy or restaurant.

The biggest difference to know about is how the price of real estate is determined. Residential real estate is based entirely on comparable sales and you can estimate the price based on a comparative market analysis. Conversely, commercial property is based entirely on the net operating income and capitalization rates in that market.

For residential property, to improve the value you need to improve the condition as compared to other similar properties in the area.

For commercial real estate, to increase the value you need to increase the income or lower the operating expenses.

It’s important to understand the difference between the two before choosing a niche. Each has it’s pros and cons and I invest in both types of real estate. But, you need a different approach depending on the type of real estate you choose.

Creating an Entity

Before you start shopping, you need to know how you will take ownership. If you are shopping for residential property, you will probably buy it using your own name. If you are buying commercial property, you will most likely need an entity to take ownership. This could be an LLC or Corporation.

Fortunately, foreigners can set up an LLC and the process is very simple.

The reason why creditors might want you to take ownership inside an entity is to protect the asset from liability elsewhere in your portfolio. Each LLC is a unique entity and the debts and liabilities in one are shielded from debts and liabilities in another.

So, if you do something silly in one property and a tenant gets hurt and sues, your other assets in separate LLCs are mostly shielded from this lawsuit.

The costs are slightly higher to own and operate a company, but the asset protection is well worth it both for you and for the lender.

Pick a Market

The US is massive and has hundreds of cities to choose from. You’ll need to pick one and focus on it if you want to have any chance of ever picking an actual property to purchase.

There are dozens of factors you might want to consider, but you’ll want to narrow it down to a few big factors first, then keep narrowing it down from there.

At first, you’ll want to consider the following major items:

Population Growth

You want to buy into a metro area and state that have positive population growth. This shows you that people want to live here and will move here from other places

Job Growth

You want to see new businesses opening and moving here from other areas. This shows the state and population have what businesses want – smart, educated, and hardworking employment base.

Employer Diversity

Generally, you don’t want to buy into a city that derives most of its jobs from one source. Good examples might be mining, oil, tourism, shipping, etc. If the majority of workers are employed in one industry, and the rest of the employment supports that industry, then you are set up for big problems if there is any issue in that industry.

diversification of job industry for real estate

Building Your Team

Once you’ve got all the admin stuff out of the way such as qualifying for a loan and establishing your entity, you’ll want to build a team in the city you will purchase in. Before you start looking for property, you will want to build your team.

You’ve already built some of your team, but there are still others you need to find. You should have already found a mortgage broker/lender, but now you need a good property manager, real estate broker in your target city, insurance agent in the target state, and contractors as well as inspectors.

You’ll need each one at some point and it’s good to build relationships with them before you actually start searching for property and need them. This way you won’t be scrambling around at the last minute.

But, be mindful of their time. You don’t want to take up a ton of their time asking questions when you have no business to offer them yet.

Searching For a Property

It’s finally time to start searching for property. If you’re looking for residential property, your agent will provide you suggested listings or set you up on an automated service that delivers listings to your email.

Commercial real estate is a bit trickier and will require you to know several brokers as well as use a service such as costar or LoopNet. In general, if you are buying commercial real estate, you need to get on the email list of the commercial brokers. So, you’ll need to call them all and ask to be on their distribution list.

Making Offers

Don’t be scared to make offers! Determine the value to you and make an offer based on that. If you are under the asking price, that’s OK. If you are over, that’s OK too.

The key is to make sure you get accurate financial information before making an offer. If possible ask for tax schedules or a trailing 12 month profit and loss statement. Smaller properties often don’t have these details so you’ll have to guess a bit more.

Next, take your numbers and put them into a real estate calculator so you know the cash on cash and overall return on investment. Once you know your returns and offer price, contact your broker and they’ll walk you through the process to making an offer.

Doing Diligence

Real estate is all about making assumptions then verifying those assumptions through diligence. In other words, it’s about taking risks then mitigating those risks.

What I mean by this is that you don’t have all the information available to you when you are putting together an offer. Sure, you’ve seen the general condition, some tax information, and rent roll/expenses, but you haven’t seen every unit, talked to every maintenance person, know your interest rates, etc.

Once your offer is accepted, you need to go through every line item and verify it’s accuracy. If it’s inaccurate, you need to adjust your calculator with the new information.

Once you’ve adjusted every item, you need to go back and consider if the deal still works for you or not. Don’t be afraid to back out at this point, but don’t get upset over small differences either.

At a minimum, you will want to verify the:

  • Total Income
  • Operating Expenses
  • Overall Condition
  • Upfront Cost of Repairs
  • Cost of Insurance
  • Property Taxes
  • Property Management
  • Current Rents
  • Potential Rents

It seems like a lot, but that’s why you’ve built a team. Each one of those people will help you verify a piece of information that will help you make a good buying decision.

One Thing About Banking

To help avoid financial crime, there is a law in The United States called the “know your client”  law which requires the bank to know who they are working with. In general, someone at the bank needs to know you in some capacity. This could be with an ID and an in person conversation, or it could be more or less.

Some banks allow you to do everything electronically. They may require you to fax or email copies of your ID or talk to them on the phone to establish that relationship.

Another way to open a bank account and work within the law is to establish a US account with a bank that operates or has a partnership in your home country as well. You can open the bank account in the US but verify your identity while being overseas.

Another way to avoid this hassle is to hire a property manager and just pay the costs of an international wire fee every quarter. They can collect your rents, pay your bills, and wire the profits to you every 3 or 6 months.

Income Taxes

Image result for income taxes

They say only Death and Taxes are certainties in life. In other words, the IRS always collects what’s due to it, so don’t try to avoid it. It’s better just to understand the requirements and do it.

Taxes are complicated, and they can be especially complicated with real estate because the tax laws of more than one country might apply. This is because different nations have different tax treaties with the U.S., so it’s really important to consult with a tax expert in your country as well as one in the U.S. to understand everything and make sure you are in compliance.

No treaty allows you to avoid taxes in the US, but some treaties allow you to pay just taxes in the United States. Other treaties require you to pay taxes in both the US and your home country. Additionally, the tax rates may vary depending on your nationality.

So, read the treaties, understand them, and consult with a tax professional or two.

Tax Benefits to Real Estate

In the US, real estate has some of the best tax benefits of all. You can offset the vast majority of your income and often pay little to no taxes for at least 10-15 years.

This is because the U.S. tax code allows deductions for mortgage interest, depreciation, all repairs and maintenance, property taxes, and more.

Often, you can find yourself with a ‘negative income’ on paper even though you collected rent all year long and have a profit. You can carry those ‘losses’ forward to the next year and offset even more profits.

The only catch is the IRS will capture these taxes back when you sell. They’re pretty smart over there at the IRS and know that you’ll defer most profits until sale, so all foreign owners of real estate will have an automatic 10% of the sale price withheld by the IRS until taxes are filed.

Don’t worry, they will refund the difference if you overpaid, but you will also owe any difference if that 10% wasn’t enough to cover your taxes.

Other Ways to Invest in Real Estate

There are a lot of nuances to know and it can seem overwhelming. Nothing we laid out is any more challenging than investing anywhere else in the world (in fact, it’s probably easier in the US than elsewhere). But, if owning your own property is too difficult, there are other ways to have real estate in your portfolio without actually purchasing any physical property.

Real Estate Crowdfunding

Around the year 2014  real estate crowdfunding came alive. Crowdfunding is where you can pool smaller amounts of funds together with other investors to purchase real estate.

In general, you need to have a US based entity with a local bank account. That’s because the deal sponsors don’t want to withhold 10% of the value upon sale to meet the IRS requirements for withholding.

So, create your LLC and set up your bank account and you can invest in real estate via crowdfunding.

ETFs and REITs

Another way is to buy into Exchange Traded Funds or Real Estate Investment Trusts via the stock exchange. These are generally traded on the open market and you’ll need to meet the requirements that all foreign investors in stocks need to meet.

You’ll be buying a fund that invests in real estate without having the purchase the real estate for yourself. You won’t earn as much because of the management fees they charge, but you also won’t have to jump through all the hurdles of buying real estate.

Private Lending

There are few laws about conducting business in the US as a foreigner. As long as your company is set up, you have a bank account, and follow the law, you can do business.

So, you could become a private lender. Basically, instead of buying real estate yourself, you could be the ‘bank’ that lends on the deal. Investors are often looking for short term loans at a high interest rate to fund their deals.

If you know some investors, it may a good option for you.

Don’t Be Intimidated

Real estate investing is a big undertaking regardless if you are a US citizen or a foreign national.

You just need to know the steps, understand the risks, build the right team, and work hard at it. If you do all that you can achieve anything, including buying real estate in the US.

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

Real Estate Investing

Commercial Real Estate: Property Types And Classes

Published

on

Before you start investing in commercial real estate, regardless if it’s via online crowdfunding or through a syndication, you want to know what sort of investment you are getting into.

In general, crowdfunding and syndications both invest in commercial real estate. Single-family properties are too cheap for developers to raise capital on. There is a fixed cost of raising capital. So, developers focus on $1m+ properties.

And usually those are commercial real estate projects.

Since commercial real estate is new to most investors, we’re going to cover the different property types within commercial real estate, as well as the different classes of property and neighborhoods.

Asset Class vs Property Type vs Property Class

An asset class is a group of investments that have similar characteristics and behave similarly in the marketplace.

Equities (stocks), fixed income (bonds), and cash equivalents (money market) are the 3 traditional asset classes. Additionally, there are 2 alternative asset classes that are extremely common as well – real estate and commodities.

There are a whole host of alternative asset classes which professionals may agree or disagree on them, such as valuable art, numismatics, or other collectibles. Increasingly many are looking at crytpo currencies as an alternative asset class.

Each asset class can further be broken down. For example, there are 11 sectors for stocks (healthcare, industrials, technology, etc).

A lot of people will ask about asset classes in real estate. What they actually mean to ask is about property types within the asset class of real estate. There are no asset classes within real estate because real estate is an asset class.

Property types are what the real estate asset class is broken down into. Just like stocks have 11 sectors, real estate has a variety of property types from office to multifamily.

Real estate does have a “class” rating system as well, which may be part of the reason why people confuse the terminology.

Property classes in real estate are referring to a rating system we use in the real estate industry to help us categorize neighborhoods and property types. This is generally on an A to D rating scale where A is the nicest properties and D is the oldest and most run down.

Real Estate Property Types

The asset class is an overarching and very broad type of investment. Within real estate, there are 4 primary types of property which include:

  • Residential
  • Commercial Real Estate (CRE)
  • Industrial
  • Land

Each one of these can be further broken down. For example, farming and resource extraction (mining and oil) are uses for raw land.

We’re going to focus on commercial real estate because that is what most investors are buying when they want to buy income producing property.

Types of Commercial Real Estate

There is almost an unlimited number of types of commercial real estate, but here are the most common ones you’ll see.

Multifamily

Multifamily is a type of commercial real estate because the owners buy it to produce income, not to live in.

Multifamily is anything that is 5 units and above (in the United States).

There’s really no reason for it except that the primary mortgage lenders Fannie Mae and Freddie Mac will back personal/residential mortgages on any owner occupied property 1-4 units, but not 5 and above.

So, a homeowner can get a traditional mortgage on a 4 family, not on a 5 family.

4 family properties are technically multifamily. But, they are excluded because they are bought by typical homeowners. Commercial multifamily property is exclusively 5 units and above.

Garden style, mid-rise, and high-rise buildings are 3 sub-categories of multifamily to be aware of.

Retail

Retail is the subcategory of commercial real estate that includes all shopping. This includes everything from a building with a single retail tenant in it (such as a fast food restaurant), all the way up through shopping plazas or even shopping malls.

It is a really complicated space because there are a variety of lease terms that can directly impact the value of the asset. For example, a single tenanted building with a lease that is about to expire is worth far less than the same building with a new 10-year lease.

Additionally, there are different types of malls, shopping centers, outlets, and more that complicate the space.

Regardless of how they are broken down, they are all considered retail.

Office

Similar to retail, these can be multi-tenanted or single-tenanted. But, unlike retail, these can range from giant skyscrapers to small office condo developments.

Self Storage

Self-Storage is relatively new to the list and is not included in most other breakdowns of commercial real estate. But, it should be.

Self-storage is one of the fastest growing and most stable CRE investments available. Supply simply cannot keep up with demand in many markets, and available spaces are being leased up at unbelievable rates.

Hotel

These are properties that are owned and operated for the purpose of very short term rentals. Can also include motels.

Mobile Home Parks

Mobile Home Parks are a huge sub-category. It’s often overlooked or counted as a sub-category to multifamily, but that’s not accurate.

Mobile home parks were very popular in the 70’s and earlier, but few new MHPs have been built in several decades. As such, occupancy is high and stable.

On the other hand, infrastructure is aging and investments in underground water/sewer, roads, and electrical can be very costly.

Special Purpose

This just captures all the other unique types of commercial real estate out there such as amusement parks, bowling alleys, and more.

Classes of Property

In residential and multifamily, the property/neighborhood class is a rating from A to D. It describes the overall age and quality of both the neighborhood and the individual property. For example, you might hear that this is a C class property in a B class neighborhood.

Multifamily is anything that is 5 units and above (in the United States).

There’s really no reason for it except that the primary mortgage lenders Fannie Mae and Freddie Mac will back personal/residential mortgages on any owner occupied property 1-4 units, but not 5 and above.

So, a homeowner can get a traditional mortgage on a 4 family, not on a 5 family.

4 family properties are technically multifamily. But, they are excluded because they are bought by typical homeowners. Commercial multifamily property is exclusively 5 units and above.

Garden style, mid-rise, and high-rise buildings are 3 sub-categories of multifamily to be aware of.

Retail

Retail is the subcategory of commercial real estate that includes all shopping. This includes everything from a building with a single retail tenant in it (such as a fast food restaurant), all the way up through shopping plazas or even shopping malls.

It is a really complicated space because there are a variety of lease terms that can directly impact the value of the asset. For example, a single tenanted building with a lease that is about to expire is worth far less than the same building with a new 10-year lease.

Additionally, there are different types of malls, shopping centers, outlets, and more that complicate the space.

Regardless of how they are broken down, they are all considered retail.

Office

Similar to retail, these can be multi-tenanted or single-tenanted. But, unlike retail, these can range from giant skyscrapers to small office condo developments.

Self Storage

Self-Storage is relatively new to the list and is not included in most other breakdowns of commercial real estate. But, it should be.

Self-storage is one of the fastest growing and most stable CRE investments available. Supply simply cannot keep up with demand in many markets, and available spaces are being leased up at unbelievable rates.

Hotel

These are properties that are owned and operated for the purpose of very short term rentals. Can also include motels.

Mobile Home Parks

Mobile Home Parks are a huge sub-category. It’s often overlooked or counted as a sub-category to multifamily, but that’s not accurate.

Mobile home parks were very popular in the 70’s and earlier, but few new MHPs have been built in several decades. As such, occupancy is high and stable.

On the other hand, infrastructure is aging and investments in underground water/sewer, roads, and electrical can be very costly.

Special Purpose

This just captures all the other unique types of commercial real estate out there such as amusement parks, bowling alleys, and more.

Classes of Property

In residential and multifamily, the property/neighborhood class is a rating from A to D. It describes the overall age and quality of both the neighborhood and the individual property. For example, you might hear that this is a C class property in a B class neighborhood.

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

Continue Reading

Real Estate Investing

What is Debt Service Coverage Ratio and Why it’s Important?

Published

on

There are few numbers more important in commercial real estate than the debt service coverage ratio.

It’s one of the first things and one of the last things that any commercial lender or broker will talk about. It’s first and last because it’s simply that important!

A lot of people toss this term around without explaining it while others are using it without fully understanding it. It’s a lot more than just a simple formula and when you understand the debt coverage ratio, you’ll be able to control it to get maximum financing.

Let’s dive into it.

Why the DSCR is Important

Imagine finding a commercial property worth $400,000 and you need to put 25% down.

You think, “alright, I can afford that!” and move forward with the deal, expecting $300,000 in loan proceeds.

As you approach closing, your mortgage lender calls you to say “The maximum loan we can give you is $225,000 because the debt coverage ratio is too low.”

Now what do you do?

This is real and happens every day. To avoid a situation like this, you need to fully understand the debt service coverage ratio before you make offers.

The fact is that it’s regularly used by banks and loan officers to determine if a loan should be made and what the maximum loan should be. If you don’t have the extra money laying around, you won’t be able to close the deal and you’ll lose a lot of money.

Debt Service Coverage Ratio Defined

The debt coverage ratio is a simple ratio that tells a lender how much of your cash flow is use to cover the mortgage payment. It’s known as the debt service coverage ratio, debt coverage ratio, DSCR, or DCR.

Debt Service Coverage Ratio Calculation

In general, it’s calculated as:

Debt Coverage Ratio

where:

Net Operating Income = Gross Income – Total Operating Costs

Debt Service = Principal + Interest

To calculate the debt coverage ratio of a property, first, you need to calculate the NOI. To do this, take the total income, subtract any vacancy, and also deduct all operating costs.

Remember, operating costs do not include debt service (principal and interest), or capital expenditures. Insurance and taxes are operating costs, so don’t forget to include them.

Next, take the Net Operating Income and divide it by the annual debt service, which is the sum of all principal and interest payments during the year.

To do this you must take the entity’s total income and deduct any vacancy amounts and all operating expenses. Then take the net operating income and divide it by the property’s annual debt service, which is the total amount of all interest and principal paid on all of the property’s loans throughout the year.

How The Debt Ratio is Used

A Debt Coverage Ratio below 1 means the property does not generate enough revenue to cover the debt service while a debt ratio over 1 means the property should, in theory, generate enough revenue to pay all debts.

It’s very common for lenders to require a 1.2 DSCR, give or take.

If your debt coverage ratio is too low, the only way to make it work out better is to reduce the loan balance. Your NOI is the same but now your principal an interest decreases, making the ratio go up.

And that’s how you can get your loan proceeds cut dramatically.

Debt Coverage Ratio Example

Let’s say there is a property that generates $10,000 in revenue, has total operating costs of $4,800, and yearly debt service of $4,000

NOI = $10,000 – $4,800 = $5,200

Debt Coverage Ratio

In this example, the debt coverage ratio is above 1.2, so this would be a good risk for the bank and they’d likely give the loan.

Let’s say that interest rates change and the bank gives a slightly higher rate, causing a new debt service of $4,500.

DSCR

Notice how a small change can suddenly change everything!

The Bank Will Reduce Your Loan

Image result for bank loan

In this situation, the bank probably won’t reject the loan. Instead, they will reduce the loan balance until the payment comes in line with their minimum DSCR requirements.

In this situation, the lender will simply reverse the formula and determine what the maximum debt service can be. We can plug in the variables we know to solve for the allowable debt service

1.2 = $5,200 / Max Debt Service

Max Debt Service = $5,200 / 1.2

So, the maximum debt service can be $4,333. Now they just need to figure out what loan balance that will be based on their interest rate and loan term.

…and you’ll be stuck trying to squeeze some quarters out of your couch to pay for the extra down payment.

How the Debt Ratio Affects Returns

In the example above I showed how a loan can be adjusted down before the lender will give the loan. This can significantly reduce your cash on cash returns.

Let’s say you are buying a property in the example above costs $100,000 and requires a down payment of $25,000.

Let’s also say that it generates $10,000 in cash each year and has an NOI of $5,200.

Originally the debt service was supposed to be $4,000 per year, leaving $1,200 in total cash flow.

Now, let’s calculate our cash on cash return. We know that it’s calculated as:

Cash on Cash Return =  Total Cash Flow / Total Cash Invested

CoC = $1,200 / $25,000 = 4.8%

This means that for every $100 you invested, you get back $4.8 every year, cash in the bank. This is not to be confused with the overall return on investment.

But due to some fluke, the terms changed and now the debt service will increase. Let’s say that the interest rates increase so your $75,000 loan is at 4.5% now and your debt service goes up from $4,000 per year to roughly $4,560/year. You can see that the new debt service coverage ratio is well below the 1.2 minimum.

I’ll spare you the math, but when I punch it into a calculator I find that the maximum loan value is now roughly $71,000. This creates a yearly debt service of $4,320, bringing you back to 1.2

Comparing The Two Scenarios

Since you’re loan has gone down, you will need to invest an extra $4,000. You’ll also have a lower cash flow because of the higher debt service.

Cash Flow = $5,200 – $4,320 = 880.

Now let’s compare two scenarios. Imagine if you were still able to get 25% down, your cash on cash would look like:

CoC = $880 / $25,000 = 3.5%

Not very good, right? But, that’s because of the increased interest rates.

Now, let’s see how the change in the loan amount affects your return. Remember, your down payment is no longer $25k because it became $29k.

CoC = $880 / $29,000 = 3.03%

Even worse…

Never Neglect the Debt Coverage Ratio

You can see how important this simple ratio is to banks. It can change your returns, your down payment requirements, and it can even kill your deal.

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

Continue Reading

Real Estate Investing

Real Estate: Is It In A Bubble?

Published

on

I originally wrote this article 6 months ago but the same question applies so I’m updating and improving it. The question still applies, is real estate at a bubble? Is it at the top?

I was at the bar for a friend’s going away party and a random guy at the bar started telling me how I needed to buy some new coin. Not Bitcoin, he said, but some other coin he had discovered that is going to make you rich.

In fact, he had just quintupled his money since this morning. I needed to hurry up and get in on the action!

…When the local regular at a small bar in small-town USA has finally started giving investing advice, it’s time to move on to the next big thing. So, I’m done with cryptocurrency (until it collapses).

Mind you, I wrote those words back when Bitcoin was was reaching new highs every day (it’s since lost 90% of it’s value)

But, What About Real Estate?

Ten years ago when I got started in real estate, everyone thought it was a terrible idea.

“If it was so easy everyone would do it.”

“Don’t you think real estate is too risky?”

You know the lines. I heard them all. But now, real estate is the best investment on the planet.

A huge number of friends and also former co-workers of mine have jumped into real estate investing within the last year. People who used to warn me how dangerous real estate was are now telling me real estate is probably the best thing to get into (except cryptos, of course!).

It’s the “best” because their best friend’s, uncle’s, nanny just house-hacked a home and earned $50k and quit being a nanny and is now a full-time house flipper!

Or…someone they knew bought a house 3 months ago and already sold it for $20k profit!

Maybe…their friend’s nephew just became a landlord though he’s 19 and doesn’t really even have a stable job (so he’s technically “retired”, right?).

The Vibe in Real Estate

If you’re getting this feeling or this vibe with any sort of investment, you need to be very cautious. Every time I’ve seen it, it’s been bad.

I turned 18 in 2003. Though I was young, I remember the boom years – I was 16 and everyone was offering me part time work at $10-$12 per hour to do construction work that I had no idea how to do.

When I was 18, 19, and 20, I was remodeling apartments at $10-$15 per hour though I had basically no experience.

Everyone was making money and throwing it around. Then I graduated college in 2008 and the economy collapsed.

It was the same feeling with cryptos. Everyone was excited about them, now I never hear about them anymore.

…and now, everyone I know has become real estate investors.

Real Estate & Economic Fundamentals

When your gut tells you something, you need to pay attention. But, I question myself at the same time.

Housing inventory is chronically low which is forcing housing prices to go up. House construction simply can’t keep pace with demand and the same is true with apartment developments.

Interest rates are dampening demand. If interest rates continue to rise, it could affect the entire economy, but the Fed has signaled it might slow or stop their interest rate increases.

The economy is great, unemployment is rock bottom, real estate prices are increasing. New wealth has been created by the trillions in the last year or two.

Stocks are going through a correction, but stock prices are not an economic indicator. If they get too low it can change people’s perceptions of the economy though and reduce spending. So, we need to pay attention to it.

Wages are growing faster than inflation for the first time in decades.

But, cap rates are amazingly low and property prices are ridiculously high compared to the income being produced. This means people prefer real estate over other investments.

Economists are constantly revising up their estimates for growth.

But… the yield curve inverted, at least on part of the curve, which usually signals an upcoming recession within 1-2 years.

So, which is it? Is real estate at the top or are economic indicators showing strong fundamentals?

Image result for real estate rates

Is it Rational or Irrational Exuberance?

Well, my crystal ball is as clear as yours. No one can predict the future but here’s my take.

I don’t feel that all signs point to bubble yet because there is enough conflicting thoughts to make me believe we aren’t quite there yet. Real estate is cooling down, but a lot of that is due to interest rates. If they don’t continue to rise, then real estate should be more stable or continue to rise.

For now, though, all we can do is to plan and to prepare. Here are your options.

Joining The Herd.

Most people invest a lot and take risks when times are great, but pull way back when times are bad. They dump $50k into stocks then when they drop 20%, they immediately sell to protect them from further losses.

Then once stocks have dropped 40%, they are too scared to reinvest until stocks are back up or higher than where they were before.

People jump into bitcoin when it’s 15,000, ride it to 17,000, then dump it when it gets to 10,000.

This is the herd mentality and is the absolute wrong way to invest.

Back in 2007, they were giving loans to anyone with a pulse but by 2011 it was basically impossible to get financing, even though housing was at rock bottom prices.

When properties could be bought for literally 40 cents on the dollar, nobody was lending and nobody was buying.

Bucking The Herd…

The hardest part of doing the opposite thing is you’ll have some serious FOMO (fear of missing out).

I know people who have made $200k+ in cryptos. FOMO was taking hold of me and I almost I actually invested $1,000 into bitcoin right around $15,500. I played with it for a week or two and sold it, losing roughly $3. That is not a typo.

I did it for fun because investing due to FOMO is the absolute worst reason to invest. A lot of people put a ton of money into it right at the wrong moment.

Instead, I believe people should invest when times are great and invest way more when times are bad. Also, I only want to invest in well known and historically good investments. In a way, it’s like dollar cost averaging.

Using the above example, if the market is hot, I wouldn’t dump all $50k into the market. Instead, I might dump $20k and leave $30k cash. As the market drops, I keep buying more. If it goes up, I buy more too, just more slowly.

In fact, this is almost exactly what I did during the market crash after Lehman Brothers collapsed. I invested my life savings in the beginning of september 2009 and lost half 2 weeks later.

I was somehow able to make all my money back within about 6 months because of dollar cost averaging.

Dollar Cost Averaging Works in Real Estate

The fact is that nobody knows when we will be at the top and nobody knows how hard the market will correct when we get there. It could come in 3 years or it could come tomorrow.

3 years ago I knew a person who sold a lot of their multifamily because they said we are at the top. 3 years later they lost out on a ton of money because it’s still going strong.

So, if you held back your investments today, you could lose 3 more years of a bull market.

My point is, I wouldn’t avoid buying. Just buy a deal or two, buy them right, and focus on adding serious value to keep you above water when the market corrects.

During a correction, use your capital reserves to really get in and buy as many properties as possible with as little money as possible. Don’t focus on adding a lot of value, just focus on getting them cash flowing.

Adding value means typing up capital. Tying up capital means buying fewer properties for huge discounts.

So, save those improvements for when the market is hot and deals are hard to find.

How Are You Planning to Invest in the Next Few Years?

Are you following the herd and diving in, or are you bucking the herd and doing the opposite.

 

This article originally appeared on IdealREI. Follow them on FacebookInstagram and Twitter.

Continue Reading

Trending