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Income Property Survival Guide Joe Lumbley, President JP Lumbley & Associates, LLC www.dallasincomeproperties.com
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Get Rich Quick (GRQ) Main purpose is to sell seminars and books How else can they afford 30 minute infomercials? Sell the dream, not the reality So, why not sell the truth? Can’t give the truth away in most cases, much less sell it It’s not what people want to hear. It’s not the easy way.
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The Rare GRQ Deal: Make Haste Slowly Sometimes lightning strikes. But only those who’ve managed to place a lightning-catcher in just the right place will benefit How to catch lightning Think ultra long-term. Befriend lots of property owners. Treat them right. Stay in touch. Be very low-key. Don’t try to convince or to sell. Learn from these owners. Let them know you appreciate it. Ask their advice on other deals. Let them know that you’d like to become an owner yourself someday. Wait for them to decide to sell and make them an offer then. Happens most often with property managers, relatives
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Get Rich Quick: Fallacies Most sellers are intelligent people. Many are also active buyers themselves, and they’ve seen it all. GRQ (get rich quick) deals, if they’re even for real, are the extraordinary deals. You cannot base a long-term business plan on just finding extraordinary deals. Remember the bell curve
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The Bell Curve
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What they didn’t cover in the get-rich-quick books Classic pyramid. Only those at the top make any real money. Professionals will just flat-out ignore you. Sellers are seldom desperate enough to accept such flaky deals.
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Advantages of Real Estate Investing Everybody’s got to live somewhere Not making any more of it—finite supply History of year-to-year appreciation Tax benefits You control it more than stocks & bonds You already understand most of the mechanics of the process Ability to negotiate price & terms
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Disadvantages of Real Estate Investing Time-consuming. Plumbing calls in the middle of the night 24 x 7 job Stressful. Lots of money involved Antagonistic. Much of real estate is a zero sum game. Not liquid Lots of commissions & fees No guarantees. No FDIC/FSLIC. No safety net.
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Leverage What is leverage? What can you leverage? Money—OPM, Other Peoples Money Rents Net Worth Reputation Time Your network Information
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Rent Leverage Income property is valued based on revenue, not just real estate Typical apartment deal valued at 6X gross rents 20 units at $416/month ~ $100,000 revenue. Value is $600,000. 10% rent raise to $458/mo. ~ $110,000 New value is $660,000.
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Net Worth Leverage Higher net worth = more business respect, better business terms, more opportunities Net worth for most part is STATED. Very seldom do you need to get appraisals to back it up.
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Reputation Leverage Do more deals = become more of a known factor. See Net Worth Leverage. Same concepts. Works both ways. Negative reputation can kill you. It’s still a small community.
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Time Leverage What is the only thing that is 100% finite and always in limited supply? Time. Get other people working for you. Referrals, leads, employees, tenants, brokers, loan brokers, lenders. Develop systems to do deals efficiently and quickly Don’t waste your own time Don’t let others waste your time for you Deal with professionals. Don’t try to do everything.
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Seller-Centric Buying Deal doesn’t come down without both a Buyer AND a Seller. Both parties have to be satisfied Seller has inertia on his side Find out what the Seller wants Give him the minimum you can to make him happy.
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Typical, real world deals Leverage 20% down at local banks, good local credit, local history 25% down at more conservative lenders or on more borderline deals 30% down at some lenders, who may allow a seller-financed second lien.
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Seller Financing Sellers almost always want the cash. Cash talks. Sellers listen. Most of the time, sellers know the real values of their buildings. They’ll be real happy to show you how the rents will increase 50% but they’re not stupid enough to base the values of their second-lien note on those projections. When money’s easy, seller financing is very hard. When money’s tight, seller financing is more likely
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If I can’t start with zero cash, how do I start? If you don’t have good credit or you don’t have money or assets for a down payment, you need to work on those problems first. Build up your credit rating Save up a war chest Own your own home first Start making contacts Keep watching for the rare but sometimes attainable zero/low down deal but don’t build your future plans on being able to find it.
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Other Peoples Money--OPM Purchase money Improvement money Grants Hard money Tax incentives Credit cards Construction money
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Money Sources Whose money? Lenders Sellers Partners Government Tenants Buyers Family & Friends Retirement money Credit Cards Home equity
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Taxation Understanding real estate taxation is key to the entire process Ad Valorem taxes are property taxes. They’re NEGOTIABLE. Don’t take tax increases lying down Income taxes are partially sheltered by interest and depreciation deductions Capital gains taxes are due on sales profits Recapture taxes are due in year of sale and are high at 25% Understand 1031 exchanges
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Locating Income Property Do your homework Pre-qualify with lenders Have your down payment lined up Quantify what an acceptable deal looks like. Build your network Identify and concentrate on your market Use brokers Watch the ads and the online listing services Walk the area. Find properties you like. Talk to the owners. Track financial news and trends
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Purchasing Income Property Be ready to move quickly Understand the seller’s Motivation Cash needs Timeframe Special needs Offer with a respectable earnest money deposit. Offer reasonable option fees. Don’t waste your time or the seller’s. Give yourself a short-term inspection clause that allows you full access to property and records
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The Purchase Process Make an offer Negotiate price and terms of an offer contingent upon financing and inspections Inspect the property and books Re-negotiate price and terms to release the inspection contingency Negotiate and obtain any loans or financing Close the deal
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Important Terms Net Operating Income = NOI = Scheduled revenue – vacancy – expenses Capitalization Rate = CAP Rate GRM = Gross Rent Multiple Cash Flow = NOI minus debt service After-tax Cash Flow = Cash Flow – income taxes on the revenue Cash-on-cash return = cash flow / cash investment. Internal Rate of Return = IRR = current value of the entire stream of income. Includes final sale of property so includes appreciation
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Evaluating the Income Stream You’re not just buying real estate. You’re buying a stream of income to be received in the future. Actual rents or street rents? Street rents through rent surveys in the area. Actual rents (collected rents) are AFTER vacancy, so don’t try to apply a vacancy rate if you’re looking at actual receipts.
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Vacancies Apply a vacancy rate to street rents or pro- forma rents View over a year’s time Your mileage may vary. Management can play a part here Vacancies also affect other income, such as laundry and vending income Vacancies also affect expenses such as utilities and unit cleaning and make-ready Also include collection losses due to nonpayment of rent
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Quality of the Income Stream Is it real? It’s very simple to fake up rent rolls. Is it steady or seasonal? How long have the tenants been there? What’s the turnover? Are the tenants all related or all working for the same employer? How many tenants are behind on their rent right now? How many evictions have they had in the last year? Affects legal costs and fees May indicate poor tenant screening How many units are non-revenue?
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How much is it worth? Multiple ways of approaching value. All contribute to overall pricing View it like a bond CAP rate = NOI/price. Lower CAP=Higher Price. CAP rate ~ interest or yield on a bond View it like a stock GRM = Gross Rent Multiple = Price/Annual Income Lower is better GRM ~ earnings multiple View it like a house Price per unit Price per square foot View it like a business Cash-on-cash return After-tax cash-on-cash return
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View it like a bond This is an “intrinsic” method of valuation Does not consider financing. Looks at value as though there were no financing at all on the property. Not affected by leverage Doesn’t consider taxation Doesn’t consider appreciation in value Adaptable to any type of income property Conservative approach. Bankers use it, as do big all-cash buyers like pension funds
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View it like a Stock Stock is really a pretty weak analogy, but bear with us GRM is like an earnings multiple based on gross earnings Doesn’t consider financing or leverage or taxes Considers appreciation to a small degree. As gross rents go up, value goes up.
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View it like a House Comparable sales Limited MLS information available Some specialized registries like Roddy Report Price per unit Price per square foot Comparable GRMs Comparable CAP rates Comparable cash-on-cash
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View it like a Business Before- and After-Tax Cash flows Considers financing Affected by leverage. More leverage = more money financed = more debt service = less cash flow After-tax cash flows take into account income taxes
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View it as Income Property Melding of all the methods above Internal rate of return (IRR) considers everything Cash flow Allows you to assume % increases in revenues and expenses Appreciation Allows you to assume net cash in a sale down the road Taxes Income tax Capital Gains Recapture Alternative investments. IRR allows you to assume a reinvestment rate of return on cash flows
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The Process of Valuation Use house-like valuation to eliminate obvious clunkers Evaluate the income stream Use GRM and CAP rates to further refine whether you even want to spend more time on the deal and to get closer on price Use business-like methods to refine further and to decide whether the investment meets your criteria. Use IRR to determine property’s value to you and to prepare presentation materials for your lenders.
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What next? Expanding your holdings. Can use IRR methods to calculate your current IRR on existing investments Look at the rate of return curve Sell, trade, or refinance when the IRR drops below what you can get on new deals This method can work to help convince sellers that it’s OK to sell. Refinance and pull cash out of the deals— this is the only place where GRQ concepts really apply. Consider 1031 exchanges rather than sales
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Summary Do it NOW. How long do you plan to live? Forget everything you learned in television seminars Develop a method that works for you and then stick with it. This is business, not emotion. You’re not looking to LIVE here. You’re looking to cash the checks from others who live here. Remember, not every at-bat is a home run. If you only swing at home run balls, you’ll miss a lot of singles, doubles, and triples.
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For more information Joe Lumbley 214-941-3417 Joe@lumbley.com Monte Self monte@lumbley.com www.dallasincomeproperties.com www.dallasincomeproperties.com Thanks for your time. Hope you gained something from this presentation!
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